revenue vs. income vs. earnings vs. profit

Factual Questions
#1

I’m going to start with the terms I think I understand, and move to the ones I don’t. Please correct the ones I have wrong, and explain the ones I don’t understand.

I’m pretty sure I understand revenue. Revenue is the money you bring in from your usual business activity. E.g., if I have a company that sells sprockets, and I sell 100 sprockets at a price of $5 each, then my revenue is $500 dollars.

I think I understand income. Income is the money you bring in minus the money you spend - but it comes in different flavors:

[ul]
[li]Gross income is the revenue you made from selling stuff minus the cost to make what you sold (at least for a company that sells stuff; I’m not sure what it means for other kinds of companies.) So, if I sold 100 sprockets at a price of $5, but each sprocket cost $3 to make, then my gross income is $200.[/li]
[li]Operating income is the money you make from your main business function (e.g., selling stuff) minus the money you spend on your main business function. This differs from gross income in that it includes things that don’t scale with how many units you sell, e.g. salaries, rent you pay on the sprocket factory, etc. This is where I don’t understand the distinction if a company doesn’t actually sell products. And I’m not totally clear on whether some of your salary expenses should be included in gross income - presumably the number of hours of work you pay the folks on the assembly line scales with how many units you make, right? I’m also not clear on if this includes the cost of unsold units.[/li]
[li]Net income is the total money you bring in minus the total you spend. This includes things that aren’t related to your main business function, like if you won or lost a lawsuit, or if you made money from some investments that went up in value, or taxes.[/li]
[li]Pre-tax income - I think this is the same as net income except excluding income tax from the calculation?[/ul][/li]
I don’t understand profit or earnings. I’ve seen some sources that seem to be saying earnings means operating income, and profit means net income. But I’m pretty sure I’ve seen “gross” and “net” applied to profit and earnings as well. So are they really just synonyms for income?

Is there a standard meaning of “income” when it isn’t modified by “gross”, “net”, etc.? Or is it ambiguous? What about “earnings” or “profit”?

I’ve also read that net income isn’t the same as the change in your money held, because “you could be reinvesting that money in the business”. But I don’t understand that - shouldn’t the money I “invested in the business” be part of my expenses in the net income calculation?

#2

Words like income, earnings and profit all need to be clarified in order to clearly understand what is meant. While we understand the gist of what’s meant by using the simple word, there are multiple ways to measure those things, and so no single unqualified definition exists. They are pretty much synonyms until someone defines them.

Even revenue probably needs some clarification. You could take a whole college-level course just on “revenue recognition” - that is, how you measure when something has actually been earned.

Defining these terms are so important that most people have never even seen a proper Income Statement or Balance Sheet. They think they have because they looked at a list of accounts and dollar values… but from a CPA’s perspective, if it didn’t come with pages of definitions, disclosures and notes, then it wasn’t a complete statement. A CPA would lose his license if he printed something straight from QuickBooks and called it a Balance Sheet. Why? Because none of those terms mean anything until you define them. To leave them undefined is to be vague at best and misleading at worst.

Anyway, to go back to your question about net income and money held… The answer is no, money spent by the business is not necessarily an expense. (This is why accounting folks often use the term “expenditure”). For example, let’s say the company buys land for $1 million. The land is not an expense; it’s actually an asset, which is pretty obvious when you figure that the company can call their realtor and sell the land. So in the first year the company purchased the land, they are down $1 million cash, but they do not have $1 million in expense. All they did was move value from one asset (cash) to another asset (land).

All kinds of things represent expenditures that are not expenses. And it gets worse: let’s say the company also bought a building on that land. The building is worth $1 million. A building is depreciated over 39 years. So this year, they are down $1 million cash, with only 25,600 of expense. Next year, there’s no change in cash at all… but they’ll have an expense of another 25,600.

In ten years, they refinance the building, taking out a new mortgage. $500,000 of new cash shows up… with no affect on income or expense.

So… one of the first thing you learn in accounting is that income and cash are unrelated. In accounting, there’s a Statement of Cash Flows, which is just as important as the Profit & Loss to people who know what they’re looking for.

#3
#4

I googled and found that and many other sources before posting the question. Mostly I found a bunch of similar sounding definitions for the terms, but using slightly different wording, leaving me unclear on whether they’re synonyms or not. Hence my questions.

For instance, Investopedia defines profit as “a financial benefit that is realized the amount of revenue gained from a business activity exceeds the expenses, costs and taxes needed to sustain the activity”, and defines net income after taxes as “what the company earned after all its expenses, charge-offs, depreciation and taxes have been subtracted”. Are those the same? Hell if I know.

#5

Maybe start with the Khan Academy course on accounting for a easy to understand overview of the basics.

The distinctions can get a bit subtle but all of this is covered in a basic accounting 101 course.

#6

Thanks for the reply, dracoi. Your explanation (of how a purchase is just turning money into some other asset, and thus isn’t the same as an expense) was very clear. So that part, at least, makes a lot more sense to me now.

#7

I am no accountant, but when I was a fleet manager in a failing company, we sold our entire fleet of vehicles to a leasing company and started to lease them. As I understand it, this was a device to move the cost of replacing vehicles from the capital budget to the revenue budget.

Since we were in part judged by our returns against capital invested, this improved the ratio and gave us a cash injection as well.

#8

FWIW, all contractors* in Oregon are required to take a 16-hour class, which covers things like contract law and taxes. In this class, they teach that the three numbers you need to worry about are:

revenue - all the money you take in from your customers.

gross profit - how much of your revenue is left over after you subtract the hard costs (costs which can be directly attributed to a specific job, such as the cost of materials used on that one specific job).

net profit - how much of your gross profit is left over after you subtract the soft costs (also known as “overhead”, expenses that are necessary but can’t be attributed to a specific job or customer, such as paying rent on your building, and buying liability insurance).

Also, taxable income is usually not the same as net profit because your actual expenses which you pay in reality don’t line up perfectly with what you’re allowed to deduct. For example, you might deduct the business use of your personal vehicle at the standard rate of 56 cents per mile even though your actual expense of running the car was only 49 cents per mile. Consequently, your taxable income would be lower than your net profit. OTOH, the tax itself can be considered a soft cost, so that tends to make your net profit lower than your taxable income.

*In this context, we are talking about businesses which operate in the construction industry and consequently must be licensed by the Construction Contractors Board. In order to obtain a CCB license, the business must designate an owner/manager/supervisor to be the “Responsible Managing Individual”. This RMI is the person who must take the 16 hour class and pass a test. The word “contractor” can also refer to a person who does work for the company but isn’t an employee; that’s not what I’m talking about here. I am not an accountant, but I am an RMI with an Oregon CCB license.

#9

Net Income is an accounting number derived from taking into account all the things that are necessary in running an enterprise. It can include all sorts of arcane things that you really don’t fully understand, but your accountant will tell you that it’s appropriate because mumublemumble. This can also be called “profit”, but “Net Income” is the standard US term in accounting.

Revenue is anything you take in as part of your business that adds to the net worth of the company, and ignores whatever costs that it took to get it. A total Sales figure is Revenue, but if you had a savings and loan company, you wouldn’t include loan repayments, only interest.

Gross Profit is normally only talked about in concerns where goods are manufactured or bought and then sold. If you run a temp company, then services would also fit in here. Gross profit is the revenue from the sale less the direct cost of the product that you sold. For a retailer, it’s the sales price less the price the retailer paid. In a temp company, it would be what you charge businesses beyond what you pay the temps. For a manufacturer, the lines can get a bit blurred here, as you will often assign a lot of costs to inventory that are more general in nature, but can be traced back to the need to having to produce the product. For a factory that also does repair work and houses the accounting offices as well, you would have to allocate the costs of maintenance of the entire factory (as well as depreciation) to the various things in the company; at least some of those costs should be traced into the inventory produced and thus subtracted out when calculating Gross Profit.

Operating Income (Net income from Operations) is Gross Profit less all the other expenses that are part of the operations of the company. Unless you’re in the financial business, interest (whether paid or received) is generally not considered part of this. Interest is a cost of financing the rest of your operations, but it’s comparable more to a dividend in the sense that it’s paid to someone who gave you money in return for them giving you money - it doesn’t impact whether the primary business is operating at a profit or not. If, for example, you had financed all your operations with stock, you wouldn’t be paying interest, but your investors would be expecting more dividends. You have less net income if you take on debt, but your operating income is the same, and that’s what someone looking to invest in your business wants to see: just what is the return on capital before considering the cost of capital? Operating income also doesn’t include things like the gain or loss from a one-time sale of capital assets that gets included in Net Income.

Pre-tax income would be Operating Profit combined with all the other sources of profit and loss that are not part of the normal operations of the company, and the sorts of things included are mentioned above.