Revenue vs Profit: Key Financial Indicators Explained Simply
Introduction
When developing an investment strategy, a key component is a company’s ability to generate revenue and transform it into profit. Revenue indicates the scale of sales, while profit reflects the efficiency of cost management. Understanding their differences and interconnections helps investors evaluate business sustainability, forecast growth, and avoid mistakes in stock selection. This guide unveils the definitions, structure, methods of analysis, and practical applications of these indicators.
In this article, we will examine real-world examples from various industries, explore case studies of renowned companies, and provide templates for self-analysis, so that every investor can apply this knowledge in practice.
Basics of Revenue and Profit
Understanding Revenue
Revenue is the total amount of money received by a company from the sale of goods or services. There are three main types of revenue:
- Gross Revenue – all receipts before deductions for discounts, returns, and taxes.
- Net Revenue – revenue after deducting returns, discounts, and indirect taxes.
- Operating Revenue – income from core activities, excluding non-operating items.
For example, Netflix’s revenue is divided into subscription fees, licensing income, and advertising revenue, allowing analysts to assess the contribution of each segment.
Understanding Profit
Profit indicates how much money remains after all expenses and taxes have been paid. The main types of profit include:
- Gross Profit = Revenue − Cost of Goods Sold (COGS).
- Operating Profit = Gross Profit − Operating Expenses (SG&A, R&D).
- Net Profit = Operating Profit + Non-operating Income − Interest Expenses − Taxes.
For instance, a smartphone manufacturer may have high revenue, but its operating profit can decline due to investments in R&D and marketing to maintain a competitive advantage.
Revenue vs Profit
Revenue demonstrates market demand and business scale, whereas profit reflects efficiency in cost management. Tesla generated billions in revenue for many years while remaining unprofitable due to high capital expenditures. However, investors focused on revenue growth realised substantial returns when the company became profitable.
Structure of the Profit and Loss Statement
Main P&L Items
- Revenue
- Cost of Goods Sold (COGS)
- Gross Profit
- Operating Expenses (SG&A, R&D)
- Operating Profit
- Interest Income and Expenses
- Taxable Profit
- Net Profit
Analysing the notes to the financial statements helps identify one-off items, such as gains from the sale of subsidiary assets, and exclude them from operational assessments.
The Impact of Structure on Analysis
Technology companies often report revenue from cloud services and subscriptions separately, allowing for an assessment of revenue stability. In industrial manufacturing, revenue by segments (regions, products) shows where a company is growing faster and where optimisation is needed.
Margins and Profitability
Gross Margin
Gross Margin = (Gross Profit / Revenue) × 100%. It reflects the efficiency of production and purchasing. For instance, Microsoft's gross margin exceeds 65%, while grocery retailers typically do not exceed 30%.
Operating Margin
Operating Margin = (Operating Profit / Revenue) × 100%. A high margin indicates effective cost management. Google demonstrates an operating margin exceeding 25% due to low operating expenses per user.
EBITDA Margin and Net Margin
The EBITDA margin helps compare companies with different depreciation and debt policies. The net margin shows the final share of income remaining for shareholders. Ratios below 10% are typical for retail, while over 20% are common for IT and pharmaceuticals.
Factors Influencing Margins
Margins depend on a company’s pricing power, cost structure, scale of business, and level of automation. Apple maintains high margins through a premium pricing strategy, whereas Walmart achieves this through wholesale purchasing and high turnover.
Revenue Dynamics and Quality
Revenue Growth Rates
Growth Rate = ((Current Revenue − Previous Revenue) / Previous Revenue) × 100%. It is crucial to analyse both annual growth and CAGR over several years. Zoom exhibited revenue growth exceeding 300% in 2020, but then growth rates stabilised—indicative of the company’s lifecycle.
Assessing Revenue Quality
The quality of revenue is determined by the proportion of recurring payments, client diversification, and the sustainability of pricing models. Salesforce derives over 75% of its revenue from subscription models, ensuring income stability.
Seasonality and Cycles
Seasonal fluctuations are particularly pronounced in tourism and retail: reports from Black Friday or holiday periods greatly impact quarterly revenue. For seasonal businesses, comparing quarters requires adjustments for calendar effects.
Valuation Multiples
P/S (Price-to-Sales)
P/S = Market Capitalisation / Revenue. This is suitable for evaluating growing but unprofitable startups. With a P/S of 10, an investor pays £10 for every pound of revenue.
EV/Sales
EV/Sales = (Market Capitalisation + Net Debt) / Revenue. This metric is more accurate as it considers debt burden and the effects of capital structure.
Industry Norms
Technology: P/S=5–15; Pharma: 3–8; Retail: 0.5–2. High P/S ratios are justified by high growth rates and margins, while low ratios often indicate stability and dividend payments.
PEG Relative to Revenue
Adapting the PEG model: PSG = P/S / Revenue Growth Rate. A PSG value below 1 indicates an attractive price given the growth rates.
Comparative Analysis and Benchmarking
Peer Analysis
Select comparable companies within the same sector and compare revenue growth rates, margins, and multiples. For example, comparing Shopify and BigCommerce showed higher growth rates for Shopify with similar P/S ratios.
Market Share via Revenue
Share Calculation = (Company Revenue / Total Market) × 100%. Revenue share growth indicates the success of a company's strategy in competitive dynamics.
Practical Tools and Data Sources
Sources
- Annual and quarterly reports (10-K, 10-Q, IFRS, RAS).
- Portals such as Yahoo Finance, Google Finance, Investing.com.
- Professional terminals like Bloomberg, Refinitiv, FactSet.
- Regulatory databases: SEC EDGAR, company websites.
Analysis Tools
Excel and Google Sheets are the primary tools for building models. Python with pandas and matplotlib is used for automating data collection and visualisation. Stock screeners (Finviz, TradingView) enable quick filtering of companies based on revenue, margins, and multiples.
Model Templates
A typical model includes historical revenue and profit data, seasonal analysis, scenario forecasts, and benchmarking. Regular data updates and testing forecasts against actual reports help enhance accuracy.
Risks and Limitations
Revenue Distortions
Companies may accelerate revenue recognition by changing payment terms or splitting contracts. To verify, it is essential to analyse the cash flow statement (CFO) to ensure revenue aligns with actual cash flows.
Macroeconomic Risks
Revenue depends on inflation, currency fluctuations, and interest rates: exporters benefit from a weak currency, while companies with fixed costs suffer in high inflation contexts.
Stress Testing
Scenario analysis (baseline, optimistic, pessimistic) helps evaluate the sensitivity of revenue to key variables and identify significant risks.
Integration into Investment Strategy
Growth vs Value
Growth investors seek high revenue growth rates and are willing to pay premium multiples. Value investors focus on stable revenue and profit, assessing companies through low P/S and P/E ratios.
Balanced Portfolio
Diversification is achieved by combining companies with varying growth rates and margins: fast-growing tech startups, stable consumer goods giants, and cyclical commodity firms.
Portfolio Example
A diversified portfolio example could consist of 40% fast-growing tech companies, 30% stable consumer goods entities, 20% in the financial sector, and 10% in cyclical industries.
Conclusion
Revenue and profit are foundational elements of fundamental analysis, revealing the scale and efficiency of a business. Their joint analysis, considering margins, multiples, and macroeconomic contexts, enables investors to make informed decisions. Employ the suggested methods and tools to assess the financial health of companies and build a successful investment strategy.
