Revenue vs profit: Real-world investors, take note!
I remember one particular day in our college Principles of Management class very clearly.
“All right, class, can you tell me the difference between revenue vs profit?” Dr. Gallo called out.
What did we do?
Yes, as you may have predicted, we collectively shifted uncomfortably in our seats and avoided eye contact with her.
It was like the day she asked, “Does anyone know the name of the Chairman of the Federal Reserve?”
Crickets then, too.
Yes, we were a bunch of morons, and she might have insinuated that a little too thoroughly because we were then entreated to a 30-minute lecture on the intricacies of revenue vs profit.
After her lecture, in true Socratic fashion, as if we were terrified 1L students whose main goal was to survive our first semester of law school, we tried to answer the questions that she fired off about revenue vs profit for the next 20 minutes as well.
Thank you, Dr. Gallo, for ensuring that I know my stuff—I only wish now that I’d still kept my notes from your Principles of Management class.
Revenue vs Profit
Anyway, what is the difference when a business flushes out its revenue vs profit?
The answer is not, as Tug Ridgeway, from that same Principles of Management class so eloquently asked, “Uhhhh… aren’t they the uhhhh…. same thing?”
Put simply, revenue is the total amount of income a company has earned—before expenses.
To explain revenue in more detail, I’ll use my favorite small shop as an example, with some made-up numbers.
At the end of its 2016 fiscal year, Molly’s Cupcakes made a total of $750,000 from the sale of its cupcakes, cakes, cookies, bars, pies, cheesecake, éclairs and ice cream.
What about if we add to this scenario? If Molly’s Cupcakes’ owner happens to be a cupcake fanatic and stock market enthusiast and has Molly’s tied up in dozens of investments that are earning dividends, is that income also considered revenue?
If you’re scratching your head, don’t worry. That part of it can be confusing. Ultimately, though, that kind of income is not considered part of revenue. Basically, Molly’s Cupcakes’ revenue is solely the income generated by its delicious products and nothing else—because that’s Molly’s Cupcakes’ product.
Now that we understand revenue (hopefully that all makes sense!) we can move on to the more detailed intricacies of profit. There are even more variations on the definition of profit, something we thoroughly learned the day Gallo went on her long-winded rampage about revenue vs profit.
Profit is, essentially, the bottom line for any company. More specifically, profit is the amount of income that remains for a business after accounting for all expenses, debts, additional income streams and operating costs.
Por ejemplo, Molly’s revenue is $750,000 for the year. However, after Molly’s owner pays the Molly’s employees, pays the electric bills, the water bills, the gas bills, makes the rent payments on the building—you get the picture—the amount “left over” is $250,000.
Therefore, Molly’s profit is $250,000 for the fiscal year.
Okay, profit is easy to understand, right?
Now, let’s dive deeper. Gross profit refers to inventory expenses subtracted from revenue.
For example, Molly’s needs lots and lots of flour, butter, eggs and sugar, plus lots of pots and pans and cooking utensils.
Therefore, Molly’s gross profit is the total amount the business made all year minus the money spent on all of those supplies.
Operating profit is exactly what it looks like—the total cost of what it takes to operate Molly’s minus the gross profit. For example, costs like rent, labor and utilities can be factored in here to figure out what the actual operating profit is.
Molly’s net profit is the total amount of money left in the bank account after every single cost has been subtracted from Molly’s revenue.
First, Molly’s owner must calculate the operating profit.
Then, Molly’s owner gets to do something that’s not so fun: Subtract one-time expenses (such as that new oven Molly’s had to buy after one of the employees burned three dozen tiramisu cupcakes to ashes.)
Once adding those in, Molly’s will get an accurate picture of the net profit of its business.
Okay, one more!
The profit margin is also a handy way to figure out how much profit a business makes per dollar of revenue.
It’s easy to figure out, once you have your revenue and profit calculated. The profit margin is a simple calculation dividing profits by revenues.
For example, we know that Molly’s total revenue for the fiscal year is $750,000, and profit is $250,000. Therefore, $750,000/$750,000= $0.33.
Ultimately, for every dollar in revenue, Molly’s makes $0.33 in profit.
How Do All These Calculations Benefit Molly’s?
Why, why, why should Molly’s owners calculate all of these different types of profit?
Isn’t it tough enough (or, depressing, really?) to simply calculate revenue vs profit and leave it at that?
Why add gross profit to the mix? Why does the profit margin matter? Why separate out operating profit?
First of all, Molly’s should do it to see where the business is losing money/gaining money. Does Molly’s employ too many bakers? Are they spending too much money on a particular brand of mixer? Are they making out like gangbusters on the key lime pie cupcakes and they should up their quantity?
All of this analysis is only going to be good for Molly’s Cupcakes, and especially as they look toward the future.
How Revenue and Profit Affect Stock Prices
Now, the small business I reference in all of these examples, Molly’s Cupcakes, isn’t a publicly traded company. However, this is an interesting angle to consider: How do both revenue and profit affect investors who hold stocks of publicly traded companies?
I think my best analysis on this topic actually does come from the days of Dr. Gallo (man, I’m realizing how much I actually did learn in that class!)
If a company’s earnings are going up, the stock price doesn’t go up directly because of an increase in earnings. Earnings are a predictor of company health, so therefore, stock prices for publicly traded companies go up because market perception and investors’ confidence in the company goes up.
The stock price of a company can fall when the company doesn’t meet earnings expectations. In the end, what happens is that investor confidence in the company decreases.
Let’s use Fitbit (FIT) as an example.
Poor, poor Fitbit.
In Q1 of this year, Fitbit had a more than $205 million decrease in revenue, and unfortunately, Fitbit’s stock has plunged to be at just about $5 today. In fact, in 2016, Fitbit stock tanked a whopping 75 percent.
Does investor confidence play a role here?
Conversely, let’s look at Apple (AAPL)—I know, what an original example, right?
(The only reason I’m using Apple as an example is because I have Fitbit on the brain and the Apple Watch is a major competitor for Fitbit.)
Anyway, Apple is one of the best-performing stocks this year. (Surprise, surprise, right?) Its shares are up 32 percent compared to the S&P 500’s six percent return in the same timeframe.
According to analysts, the Apple iPhone 8 and Apple’s other products could potentially drive the company’s value to more than $1 trillion next year. In addition, the company’s market value is just under $800 billion.
Are investors confident in Apple because of its profit and revenue?
Does the uptick in profit and revenue bolster confidence, and in this case, drive stock prices?
Oh, you bet.
As you can see, careful analysis of revenue vs profit can rally stockholders around a particular company as well as create opportunities for small businesses to see where they need to improve.
Regarding improvements, a good company will break down revenue, gross profit, operating profit, net profit and profit margin and examine revenue vs profit to see where they are spending too much money, not making enough, or even becoming left in the dust in the marketplace, just like our Fitbit example.
It’s a tricky game of numbers, but is oh, so important for any successful business.