Motivated entrepreneurs dream of dollar signs—bright, S-shaped figures that shimmer and represent the true reward of starting a venture and reaping the financial benefits of the hard work that goes into it. Once officially up and running, making money is what all small business owners strive to do each day. This can be done directly through making sales to customers, indirectly via passive income, and investing in stocks or bonds. But according to the IRS and other government agencies, there are a few terms used to classify certain types of money generated by a business. Three of these terms that often get thrown around with very little context include income, profit, and revenue.
Let’s take a moment for a brief lesson on this to clear up what these money-related words dancing in your head really mean:
- Income: In basic terms, income is any type of money that flows into a business bank account. But there are a few subcategories under the income umbrella, including gross income and net income. Gross income is the money an entity earns before subtracting any expenses, while net income is the total income obtained after expenses and taxes. Income could be generated from the direct sale of a handmade sweater sold on eBay or through rental property, which is often called passive income.
- Profit: Profit is directly associated with any products or services that a business sells. The basic formula to calculate profit is to subtract the actual production costs of a product or service from the amount a company makes when selling it. For instance, let’s say a local bike shop sells a new bike for $100. But the shop only paid $75 to obtain the bike from a manufacturer. Since $100 – $75 = $25, the net profit on the bike in this case would simply be $25. All companies strive to maximize profits by reducing their production or manufacturing costs to the lowest possible level, and then selling these goods or services at a price that is fair but is also as high above these costs as possible. In essence, a profit could be considered a return on investment.
- Revenue: Revenue is defined as actual money earned by a business. This money could be anything from sales revenue earned from selling goods or services to revenue collected from interest on investments to money that flows in as royalties. In the small business accounting world, revenue is sometimes referred to as the “top line” because this number appears on the top line of a company’s income statement. This is in contrast to the “bottom line,” which typically refers to net income after expenses and taxes have been subtracted.
To put all these terms together, a small business may earn income, which is later viewed as revenue, and is ultimately classified as profit. Regardless of the words used to describe it, though, the only way a company can truly succeed is by making money.
This article was originally published by 1800 Accountant
Published: September 23, 2014