Running a profitable business is a big challenge. Fifty percent of businesses started in the U.S. fail within the first 5 years. Why? Because they are unable to create a profitable business model.
While there are many different factors that play into running a profitable business, in this article, we’re going to focus on just one simple fact: the difference between revenue and profit. The distinction matters, and it helps immensely if the entire team has the same understanding of what profit is.
If you are the owner, it might seem like profit is an obvious fact, but that assumption could be hurting you. Profit is often confused with revenue, and understanding the difference empowers each employee to help achieve a profitable business.
Defining revenue and profit
Revenue refers to the money that you collect. This is the money that comes in from customers in exchange for your product or service. Revenue is the most visible number—it’s the number on all the jobs you’re winning and the number on the checks that you get from customers. Because it’s the money coming in, it’s the number everyone sees.
Revenue is also the number that is the simplest. The money that a business receives is straightforward, especially in comparison to the various expenses it must cover. Every business owner knows that if there’s going to be any money left at the end of the day, revenue must be enough to cover all expenses.
Profit, on the other hand, is a financial gain—essentially, it’s the difference between the amount earned and the amount spent in buying, operating, or producing something. Profit is the difference between the amount of money that is earned and the amount that is spent.
Profit is not as simple or straightforward as revenue; it can be challenging to calculate. A business owner must account for fixed and variable expenses, known expenses and ones that just pop up. Profit in one month doesn’t guarantee profit in the next, so profitable months must be able to cover those that aren’t. (For more on the different between profit and revenue, see our book Business Model, available on Amazon.)
Misunderstandings concerning revenue and profit
A common area of misunderstanding is for employees to think that the business owner gets to keep all of the money that they collect (revenue). Oftentimes, this is due to the fact that employees are on the front lines of interactions with customers and therefore see or are involved with the transactions that bring in cash. They may not be as aware of all the ways in which the business spends money—beginning with salaries but extending to areas such as rent, insurance, cost of goods, supplies, utilities, and more.
A related misunderstanding is when employees assume that if revenue is coming in, profit is guaranteed. Business owners know that’s not the case, but it’s a fact that can be easily overlooked. If revenue is the end of the story for employees, they don’t have the information they need to make informed decisions about how the company should operate.
Benefits to helping your employees understand the difference between revenue and profit
One of the primary benefits to employees understanding the difference between revenue and profit is that they are empowered to make decisions that increase profitability. Decisions made at every level of the organization determine profitability, so it makes a tangible difference when everyone shares the same understanding.
“One of the primary benefits to employees understanding the difference between revenue and profit is that they are empowered to make decisions that increase profitability.”
For example, an employee who is sourcing materials for the company’s new widget will be looking not just at the cost of raw materials, but also their long-term durability. Why? Because a better, longer-lasting widget reduces warranty claims and benefits the company in the long run, and the employee understands that better profit margins are directly tied to the viability of the company. The employee begins to make decisions more like the business owner.
Another advantage is that the employees are more in-tune with reality. Reality for a small business owner means that they must be making a profit in order to fund the business and keep the doors open. If an employee has a wrong idea about the motivation to make money—thinking it’s for greed rather than the ability to continue running—they’re not as likely to be engaged.
Employees might think that as long as the company is selling its goods and the lights are on in the building, everything is fine; their jobs are secure. But it’s quite possible they’re not considering factors like how it’s necessary to bring in enough revenue during busy times to make up for slow times. Or that, while expenses can fluctuate a great deal, it’s always difficult to raise prices.
In general, most businesses are less profitable than people assume. Employees aren’t always aware of how things like insurance premiums, payroll taxes, and overhead can eat away at profits. Being clear on what profits are and how they are affected will help employees at every level make smart choices every day.
Profitability matters to everyone, not just the owner. Without profit, there is no company. Employees who understand that fact will feel more invested and be more engaged. We encourage you to share the simple definitions of revenue and profit from this article with your team. Adopting clear language that has a shared, consistent meaning to the entire organization provides a framework for everyone to communicate about profit.
The differences between revenue and profit are part of the Business Model program – one of the 11 elements of an exceptional business. To learn more about these concepts, get a copy of the Business Model book on Amazon. Our mission is to multiply the number of exceptional businesses globally. Join the conversation on LinkedIn.