At one time or another, you have likely heard financial terms such as revenue, cost, profit, and loss. Perhaps you have seen them on financial statements, but they never really made sense to you. What is the difference between revenue and profit? Are costs the same as losses? Let's read on and clear up some of your questions.
Revenue calculations and formula
Revenue is the first figure you will see on an income statement. Its value indicates how much money a business has received from sales, i.e. from its customers.
The income statement shows the profit earned and loss sustained by a business over a particular period (usually 12 months). It shows all revenues earned and expenses incurred during the specified period. To learn more about this topic, check out our explanation Income statements.
Revenue is money that a business receives from selling its goods or services.
Company A is an ice cream shop. It sells around 1,500 ice cream portions a month, each at £5. What is the monthly revenue of company A?
If revenue from one portion of ice cream is £5 and the company sells 1,500 portions a month, then the revenue will equal £7,500. This is because £5 x 1,500 = £7,500.
There are two types of revenue: operating revenue and non-operating revenue.
Financial Terms and Calculations: Operating revenue
Operating revenue is the revenue earned by the company from primary activities like sales of goods and services.
Operating revenue is the total number of units sold multiplied by the average selling price per unit. The formula for operating revenue is the following:
Operating revenue = Number of units sold x selling price
Fig. 1 - Revenue Calculations on a Laptop
Financial Terms and Calculations: Non-operating revenue
Non-operating revenue includes everything other than revenue from primary streams. This is when a company earns revenue from different sources such as rental properties, dividends, profits, or losses from investments.
To learn more about revenue, check out our explanation, Revenue.
Financial Terms and Calculations: Cost
Cost is the second figure on the income statement. Its value indicates how much money a business spent to keep itself operational.
Cost, in other words, expense, is the amount of money that a business spends on operations.
Company B manufactures clothes. Every month it spends £5,000 on raw materials and £2,000 on rent. What are the monthly costs of company B?
If the company spends £5,000 on raw materials and £2,000 on rent, its costs will equal £7,000. This is because £5,000 + £2,000 = £7,000.
There are several types of costs: fixed costs, variable costs, semi-variable costs, and total costs (see Figure 2 below).
Financial Terms and Calculations: Fixed costs
Fixed costs are costs that are independent of business performance.
Fixed costs stay the same regardless of changes in output. Fixed costs may include rent, insurance, and loan repayments.
Financial Terms and Calculations: Variable costs
Variable costs are those costs that change as per the performance and output of the business.
These costs are highly dependent on the output of the business, as they change in proportion to it. Variable costs can include raw materials, direct labour, and transaction fees. For example, if the business increases production, it will require more raw materials.
Financial Terms and Calculations: Semi-variable costs
Semi-variable costs are costs that change when there is a large change in output.
These are costs that tend to stay the same but might change when the output significantly increases.
Semi-variable costs may include something like utility bills. The reason for this is that they tend to be the same every month, but if a business uses much more electricity than usual, they will go up.
Financial Terms and Calculations: Total costs
Total cost is the total expenditure of a business over a time period.
Total costs are simply all the costs added together.
If a business spends money on rent, raw materials, and electricity, the total costs will be all of these figures added together.
To learn more about costs, check out our explanation Costs!
Financial Terms and Calculations: Profit
Profit is a figure that, just as revenue and cost, can be found on the income statement. In fact, it is strictly related to both revenue and costs.
Profit is the money that a business makes after all costs have been subtracted from the revenue.
Similar to revenue, profit refers to money that goes into the business. However, the two terms have completely different meanings. Whereas revenue is all the money that a business receives from its sales, profit considers additional costs incurred by a business.
To calculate profit, not only do we add all the money a business has received from sales, but we also have to subtract all the costs incurred. The formula for calculating profit is the following:
Profit = Revenue - Costs
Company C is a private language school. Every month it receives £25,000 from its lessons. However, it also pays £3,000 to rent a building and £18,000 on teacher salaries. What is the monthly profit of Company C?
Since revenues are £25,000 and costs are £21,000, the profit made by Company C will equal £4,000:
£3,000 + £18,000 = £21,000 (costs)
£25,000 - £21,000 = £4,000 (revenues - costs = profit)
Sometimes a business might spend more money than it earns, and therefore make a loss.
Loss is the amount of money by which a business's costs exceed its revenues.
Company D sells handmade jewellery. Last month it received £13,000 from its sales. However, it also had to pay £1,500 to rent a building, £8,000 for employee salaries, and £4,000 for raw materials. Did Company D make a profit?
Since revenues are £13,000 and costs are £13,500, the loss made by Company C will equal £500:
£1,500 + £8,000 + £4,000 = £13,500 (costs)
£13,000 - £13,500 = -£1,500 (revenues - costs = loss)
There are two main types of profit: gross profit and net profit.
Financial Terms and Calculations: Gross profit
Gross profit is the profit made by a business after subtracting all the costs related to manufacturing and selling its products.
The formula for gross profit is the following:
Gross profit = Revenue - Cost of products sold
Financial Terms and Calculations: Net profit
Net profit is the profit made by a business after all of its expenses have been subtracted from revenues. These expenses include costs related to manufacturing and selling products, interest, taxes, and any other expenses.
The formula for net profit is the following:
Net profit = Revenue - All costs
To learn more about profits, check out our explanation Profits.
Financial terms on the income statement: Example
Figures such as revenue, cost, and profit can all be found on the income statement. Let's have a look at an example of the income statement and find them (see table 1 below).
| Example Income Statement Company XYZ | |
| Sales revenue | £120,000 |
| Cost of sales | £50,000 |
| Gross profit | £70,000 |
| Rent | £5,000 |
| Insurance | £6,000 |
| Salaries | £24,000 |
| Net profit | £35,000 |
Table 1 - Income Statement Example
In table 1, the first figure is revenue (sales revenue) which indicates how much money the business received from its sales. The second figure is cost (cost of sales) which shows the amount of money the business spent on manufacturing its products (these are variable costs).
Gross profit has been calculated by subtracting the cost of sales from revenue. After gross profit, we list the costs other than those directly related to the manufacturing of products. In this case, they include rent, insurance, and salaries, which are typically fixed costs. Finally, the last figure in the table is the net profit, which has been calculated by subtracting all the costs from revenue.
Average rate of return calculation
The average rate of return (ARR) is a calculation that allows us to see the return on investment and helps us decide whether it is worthwhile or not.
The average rate of return (ARR) is the average annual return (profit) from an investment.
The average rate of return compares the average yearly return (profit) on an investment to its initial cost. It is expressed as a percentage of the original sum invested.
If the average rate of return is 20%, it means that the average yearly profit from the investment will be 20%.
To learn more about this concept and how to calculate ARR, check out our explanation on the Average Rate of Return!
Calculation of break-even in business
The break-even level of output is important for businesses to calculate in order to know how many units of a product they need to sell to recover total costs.
Break-even is the level of output at which revenues from sales equal total costs. It is the number of units a firm has to produce and sell to recover its total costs.
When a business reaches the break-even level of output, it recovers all of its costs. When the level of output is below the break-even level, a business will make a loss. When the level of output is above the break-even level, a business will make a profit.
To explore this topic in more detail, take a look at our explanation on Break-even analysis!
As you can see, there are several financial terms that may seem similar in meaning but are actually quite different. As a student of business and/or finance, it is important to know the difference. To better understand the terms and their interrelationships, one can use financial calculations such as the average rate of return and break-even analysis.
Financial Terms and Calculations - Key takeaways
- Revenue is money that a business receives after selling its goods or services.
- There are two types of revenue: operating revenue and non-operating revenue.
- Cost, in other words, expense, is money that a business spends to operate.
- Costs can be fixed, variable, semi-variable, or total.
- Profit is money that a business makes after all costs have been subtracted from the revenue.
- There are two main types of profit: gross profit and net profit.
- Loss is the amount of money by which a business's costs exceed its revenues.
- The average rate of return (ARR) is the average annual return (profit) from an investment.
- Break-even is the level of output at which revenues from sales equal total costs. It is the number of units a firm has to produce and sell to recover its total costs.
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