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Revenue is the amount earned in a period, profit is what remains after expenses, gross profit is revenue minus direct costs, and net profit is gross profit minus indirect expenses. Turnover growth doesn’t guarantee profit, and the relationship between turnover and profit varies by industry. Management must consider the effect of decisions on both turnover and profit.
A company’s revenue is the amount of revenue it earned in a given accounting period. Profit is the amount left over after deducting the expenses incurred to earn it from the turnover. Gross profit is the amount of revenue earned from sales minus direct costs of production, such as the cost of materials and direct labor. Net profit is obtained by deducting indirect expenses, including overheads, from gross profit. Net income is, therefore, the net amount earned by the business in one accounting period; additional payments, such as taxes or dividends, may also have to come from these funds.
One difference between turnover and profit is that an increase in turnover may be a sign that the business is growing, but profit is an indicator of the health of the business. If the business can’t earn profits, it can’t continue in the long run. A profitable business can generate cash for further investment and can remain in a liquid position. Investors in the industry may want to see an increase in both turnover and profits to ensure they get a satisfactory return on their investment. Increased turnover does not guarantee increased profits, particularly if the company is unable to control its costs.
The relationship between turnover and profit depends on the sector in which the company operates. The level of turnover required to achieve a healthy profit can vary from one industry to another, depending on the profit margin on sales. Businesses in a highly competitive industry, such as grocery retailers, may earn only a small amount of profit on each sale after deducting direct and indirect costs related to the sale. Businesses such as gas stations and supermarkets need to maintain high annual turnover to ensure they make adequate profits. Other types of businesses, such as fashion clothing stores, quality furniture stores, and some service industries, are making a large margin on sales and can earn a satisfying profit with lower turnover.
Management decisions must take into account the effect such decisions will have on turnover and profit. To grow a company, management must not only focus on increasing annual revenue; it must also look at the costs of control and, therefore, the increase in profits. Carrying on a loss-making product line will increase revenue but further increase costs and, as a result, reduce profits. Management should discontinue the loss-making product to increase profits, but if the focus is only on revenue, the decision to discontinue that item may not be made. When incentives for managers are based on sales and revenue rather than profit, they may take on unprofitable contracts to increase revenue in the short term, even though profits will be reduced in the long run.
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