The Difference Between Earnings and Revenue explained in an easy-to-understand review. Earnings are reported on the bottom line of a business’s income statement. Revenue is indicated on the first (top) line of the income statement of a business.
What are earnings?
Regarding businesses, earnings are reported on the bottom line of a business’s income statement, indicating how much a business has earned after deducting all its expenses during a given financial period.
With regard to individuals, earnings refer to the money a person receives as a salary or money earned for being self-employed or as a business owner.
What is revenue?
Revenue is indicated on the first (top) line of the income statement of a business, referring to the total amount of money generated by a business for selling its goods and/or providing its services.
Earnings explained in more detail
Other designations for earnings
Earnings are also referred to as net income, net earnings, profit, or net profit.
Calculation of earnings
Businesses calculate their earnings by subtracting the following types of expenses from their revenue:
- Cost of goods sold (COGS) (for example, labour, material, and expenses directly involved in the manufacturing of goods), or when a pure service business, cost of services rendered (such as travelling expenses, sales commission, rental costs for equipment and tools).
- Operating expenses (such as rent, salaries, utilities).
- Administrative expenses (for example office supplies, insurance, legal fees).
- Imputed expenses (depreciation).
- Finance charges (interest).
- Taxes payable.
The importance of earnings to determine a business’s financial performance
Earnings are a key figure to determine a company’s financial performance, evaluating its viability and long-term sustainability.
There are various measures in which earnings can be used in order to enable analysts and investors to evaluate a specific aspect of a company’s financial capabilities. Measures such as EBT (earnings before taxes, EBIT (earnings before interest and taxes, EBITDA (earnings before interest, taxes, depreciation & amortisation, EPS (earnings per share), P/E (price to earnings), and earnings yield.
Earnings before taxes (EBT)
Earnings before taxes, also called pre-tax income, is the calculation of a business’s earnings before taxes are taken into consideration.
EBT is an important indicator because it excludes the effects of taxes on earnings when comparing the financial achievements of different businesses.
Commonly, EBT is calculated as follows:
EBT = Net earnings + taxes
Earnings before interest and taxes (EBIT)
EBIT, sometimes referred to as operating earnings, operating profit, or profit before interest and taxes, is a measurement of a company’s profitability from operations. It excludes the effects of taxes and cost of capital structure on a company’s earnings from operations.
EBIT focuses exclusively on a business’s ability to generate profit from its core operations.
Typically, EBIT is calculated as follows:
EBIT = Net earnings + Interest + Taxes
EBIT is useful when analysing companies that own a considerable amount of fixed assets (such as plant, equipment, and property) that are typically acquired by using debt.
Earnings before interest, taxes, depreciation, and amortisation (EBITDA)
EBITDA is used to determine a company’s profitability without the effects of financing implications and imputed expenses such as depreciation.
One of the methods to calculate a company’s EBITDA uses the following formula:
EBITDA = Net earnings (net income) + interest + taxes + depreciation + amortisation
Negatively, EBITDA can cause misrepresentations with regard to a company’s net earnings. Especially, concerning companies with a considerable amount of fixed assets on which depreciation is calculated.
Earnings per share (EPS)
Earnings per share (EPS) refers to a company’s profitability on a per-share basis. EPS is calculated by dividing a company’s net earnings by its outstanding ordinary shares. The outstanding shares of a company are the shares issued by the company and that are traded on the secondary market.
It is probably the most used financial measurement to evaluate a company’s value.
Price-to-earnings (P/E) ratio
The price-to-earnings (P/E) ratio, sometimes called the price multiple or the earnings multiple, is used to determine a company’s share price in relation to its earnings per share (EPS).
The P/E ratio enables analysts and investors to, inter alia:
- determine if the projected EPS of a company is accurately represented by its share price, evaluating whether the share price is overvalued or undervalued.
- compare the share prices of companies in the same industry, producing the same type of products or rendering the same sort of services,
- evaluate a company’s performance against its performances during previous financial years.
The formula for the price-to-earnings ratio is:
P/E ratio = Market value per share/Earnings per share (EPS)
Where market value is the current price of a company’s shares.
Earnings yield
Earnings yield is a financial ratio that indicates the correlation between a company’s earnings per share (EPS) for the last twelve months (LTM) and the company’s share price.
Earnings yield is the inverse or reciprocal of the P/E ratio. It is a ratio that indicates the percentage of a company’s earnings per share.
Put differently, earnings yield enables investors to determine how much earnings per share a company generates from every South African rand (ZAR) invested in the shares of the company. In other words, earnings yield measures the rate of return of a company’s shares.
For example, company TAS has an earnings yield of 10%. This means that a shareholder of company TAS has earned R10 for every R100 of TAS shares owned.
Earnings yield is calculated as follows:
Earnings yield = Earnings per share (for the immediately preceding 12 months)/Current share price
A high earnings yield may indicate that the shares of a company are undervalued. Conversely, a low ratio may be an indication of overvalued shares.
What are retained earnings?
Retained earnings are all the earnings accumulated by a company over its lifespan, less any dividends distributed to its shareholders.
Revenue explained in detail
As mentioned, revenue refers to the money generated by a business during its normal business operations, such as selling goods/products and/or rendering services to customers or clients.
Put differently, revenue is the income earned before any expenses are deducted.
Revenue is also called sales or services (in the case of a pure service business). Sometimes, revenue is also called net sales when discounts, allowances, and deductions for returned goods are included in the number of sales.
Methods to calculate revenue
Basically, there are two methods to calculate revenue:
- In accrual accounting[1], cash sales, as well as sales made on credit, are included in the revenue amount.
- In a cash accounting system, revenue comprises only sales of which payments are received.
Revenue as a financial indicator
Revenue is certainly the most basic, but important financial indicator of a business’s profitability and its financial performance as a whole.
There are many financial ratios in accounting in which revenue (sales) are used to determine the efficiency and profitability of a company. Ratios such as asset turnover ratio, gross margin ratio, operating margin ratio, and price-to-sales ratio.
Asset turnover ratio
The asset turnover ratio is an efficiency ratio that measures a company’s ability to generate sales (revenue) from its assets. The ratio is also referred to as the total asset turnover ratio.
The asset turnover ratio of a company can be affected by large sales of assets as well as considerable asset acquisitions during a given financial year.
The formula for the asset turnover ratio is:
Asset turnover ratio = Net sales/Average total assets
Where:
- Net sales = the total of revenue generated during a given financial period less sales returns, sales allowances, and sales discounts.
- Average total assets = (assets at the start of the financial year + assets at the end of the financial year)/2.
Noteworthy, either average total assets or end-of-period assets can be used in the calculation.
Typically, a high asset turnover ratio is an indication that a company utilises its assets to generate sales more efficiently than a company with a lower rate.
Gross margin ratio
The gross margin ratio, also called the gross profit margin ratio, is a profitability ratio in accounting that shows how much income a company has left after taking into account all the expenses directly involved in the manufacturing of goods and/or providing of services – referred to as cost of goods sold (COGS) or cost of services delivered.
The formula for the gross margin ratio is:
Gross margin ratio = Gross profit/Net sales
Where:
- Gross profit = Net sales (revenue) – cost of goods sold or cost of goods delivered.
- Net sales = the total of revenue generated during a given financial period after deduction of sales allowances, sales discounts, and sales returns.
Operating margin ratio
The operating margin ratio compares a company’s operating income to the company’s net sales, indicating how proficiently a company generates profit through its key operations. The ratio is expressed as a percentage.
To calculate the operating margin ratio, the following formula is used:
Operating margin ratio = Operating income/Net sales
Where:
Operating income = the amount of revenue available after the deduction of expenses from gross profit. Operating income is also known as EBIT (earnings before interest and taxes).
Net sales (see description under asset turnover ratio or gross margin ratio)
Price-to-sales ratio
The price-to-sales (P/S) ratio, also referred to as revenue multiple or sales multiple, compares a company’s share price to its revenues. The ratio indicates how much investors are prepared to pay per South African rand (ZAR) of the company’s revenue (sales) for a company’s shares.
The calculation of the P/S ratio is as follows:
P/S ratio = Market value per share (MVS)/Sales per share (SPS)
Where:
Sales per share = A company’s revenue (sales) divided by the total of its outstanding shares.
[1] See the article, ‘Accrual Accounting Explained for Dummies’, for more information about accrual accounting.
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