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# Financial Terms and Calculations

At one time or another, you have likely heard financial terms such as revenue, cost, profit, and loss. Perhaps you have seen them on financial statements, but they never really made sense to you. What is the difference between revenue and profit? Are costs the same as losses? Let's read on and clear up some of your questions.

## Revenue calculations and formula

Revenue is the first figure you will see on an income statement. Its value indicates how much money a business has received from sales, i.e. from its customers.

The income statement shows the profit earned and loss sustained by a business over a particular period (usually 12 months). It shows all revenues earned and expenses incurred during the specified period. To learn more about this topic, check out our explanation Income statements.

Revenue is money that a business receives from selling its goods or services.

Company A is an ice cream shop. It sells around 1,500 ice cream portions a month, each at £5. What is the monthly revenue of company A?

If revenue from one portion of ice cream is £5 and the company sells 1,500 portions a month, then the revenue will equal £7,500. This is because £5 x 1,500 = £7,500.

There are two types of revenue: operating revenue and non-operating revenue.

### Financial Terms and Calculations: Operating revenue

Operating revenue is the revenue earned by the company from primary activities like sales of goods and services.

Operating revenue is the total number of units sold multiplied by the average selling price per unit. The formula for operating revenue is the following:

Operating revenue = Number of units sold x selling price

Fig. 1 - Revenue Calculations on a Laptop

### Financial Terms and Calculations: Non-operating revenue

Non-operating revenue includes everything other than revenue from primary streams. This is when a company earns revenue from different sources such as rental properties, dividends, profits, or losses from investments.

## Financial Terms and Calculations: Cost

Cost is the second figure on the income statement. Its value indicates how much money a business spent to keep itself operational.

Cost, in other words, expense, is the amount of money that a business spends on operations.

Company B manufactures clothes. Every month it spends £5,000 on raw materials and £2,000 on rent. What are the monthly costs of company B?

If the company spends £5,000 on raw materials and £2,000 on rent, its costs will equal £7,000. This is because £5,000 + £2,000 = £7,000.

There are several types of costs: fixed costs, variable costs, semi-variable costs, and total costs (see Figure 2 below).

### Financial Terms and Calculations: Fixed costs

Fixed costs are costs that are independent of business performance.

Fixed costs stay the same regardless of changes in output. Fixed costs may include rent, insurance, and loan repayments.

### Financial Terms and Calculations: Variable costs

Variable costs are those costs that change as per the performance and output of the business.

These costs are highly dependent on the output of the business, as they change in proportion to it. Variable costs can include raw materials, direct labour, and transaction fees. For example, if the business increases production, it will require more raw materials.

### Financial Terms and Calculations: Semi-variable costs

Semi-variable costs are costs that change when there is a large change in output.

These are costs that tend to stay the same but might change when the output significantly increases.

Semi-variable costs may include something like utility bills. The reason for this is that they tend to be the same every month, but if a business uses much more electricity than usual, they will go up.

### Financial Terms and Calculations: Total costs

Total cost is the total expenditure of a business over a time period.

Total costs are simply all the costs added together.

If a business spends money on rent, raw materials, and electricity, the total costs will be all of these figures added together.

## Financial Terms and Calculations: Profit

Profit is a figure that, just as revenue and cost, can be found on the income statement. In fact, it is strictly related to both revenue and costs.

Profit is the money that a business makes after all costs have been subtracted from the revenue.

Similar to revenue, profit refers to money that goes into the business. However, the two terms have completely different meanings. Whereas revenue is all the money that a business receives from its sales, profit considers additional costs incurred by a business.

To calculate profit, not only do we add all the money a business has received from sales, but we also have to subtract all the costs incurred. The formula for calculating profit is the following:

Profit = Revenue - Costs

Company C is a private language school. Every month it receives £25,000 from its lessons. However, it also pays £3,000 to rent a building and £18,000 on teacher salaries. What is the monthly profit of Company C?

Since revenues are £25,000 and costs are £21,000, the profit made by Company C will equal £4,000:

£3,000 + £18,000 = £21,000 (costs)

£25,000 - £21,000 = £4,000 (revenues - costs = profit)

Sometimes a business might spend more money than it earns, and therefore make a loss.

Loss is the amount of money by which a business's costs exceed its revenues.

Company D sells handmade jewellery. Last month it received £13,000 from its sales. However, it also had to pay £1,500 to rent a building, £8,000 for employee salaries, and £4,000 for raw materials. Did Company D make a profit?

Since revenues are £13,000 and costs are £13,500, the loss made by Company C will equal £500:

£1,500 + £8,000 + £4,000 = £13,500 (costs)

£13,000 - £13,500 = -£1,500 (revenues - costs = loss)

There are two main types of profit: gross profit and net profit.

### Financial Terms and Calculations: Gross profit

Gross profit is the profit made by a business after subtracting all the costs related to manufacturing and selling its products.

The formula for gross profit is the following:

Gross profit = Revenue - Cost of products sold

### Financial Terms and Calculations: Net profit

Net profit is the profit made by a business after all of its expenses have been subtracted from revenues. These expenses include costs related to manufacturing and selling products, interest, taxes, and any other expenses.

The formula for net profit is the following:

Net profit = Revenue - All costs

## Financial terms on the income statement: Example

Figures such as revenue, cost, and profit can all be found on the income statement. Let's have a look at an example of the income statement and find them (see table 1 below).

 Example Income Statement Company XYZ Sales revenue £120,000 Cost of sales £50,000 Gross profit £70,000 Rent £5,000 Insurance £6,000 Salaries £24,000 Net profit £35,000

Table 1 - Income Statement Example

In table 1, the first figure is revenue (sales revenue) which indicates how much money the business received from its sales. The second figure is cost (cost of sales) which shows the amount of money the business spent on manufacturing its products (these are variable costs).

Gross profit has been calculated by subtracting the cost of sales from revenue. After gross profit, we list the costs other than those directly related to the manufacturing of products. In this case, they include rent, insurance, and salaries, which are typically fixed costs. Finally, the last figure in the table is the net profit, which has been calculated by subtracting all the costs from revenue.

## Average rate of return calculation

The average rate of return (ARR) is a calculation that allows us to see the return on investment and helps us decide whether it is worthwhile or not.

The average rate of return (ARR) is the average annual return (profit) from an investment.

The average rate of return compares the average yearly return (profit) on an investment to its initial cost. It is expressed as a percentage of the original sum invested.

If the average rate of return is 20%, it means that the average yearly profit from the investment will be 20%.

## Calculation of break-even in business

The break-even level of output is important for businesses to calculate in order to know how many units of a product they need to sell to recover total costs.

Break-even is the level of output at which revenues from sales equal total costs. It is the number of units a firm has to produce and sell to recover its total costs.

When a business reaches the break-even level of output, it recovers all of its costs. When the level of output is below the break-even level, a business will make a loss. When the level of output is above the break-even level, a business will make a profit.

To explore this topic in more detail, take a look at our explanation on Break-even analysis!

As you can see, there are several financial terms that may seem similar in meaning but are actually quite different. As a student of business and/or finance, it is important to know the difference. To better understand the terms and their interrelationships, one can use financial calculations such as the average rate of return and break-even analysis.

## Financial Terms and Calculations - Key takeaways

• Revenue is money that a business receives after selling its goods or services.
• There are two types of revenue: operating revenue and non-operating revenue.
• Cost, in other words, expense, is money that a business spends to operate.
• Costs can be fixed, variable, semi-variable, or total.
• Profit is money that a business makes after all costs have been subtracted from the revenue.
• There are two main types of profit: gross profit and net profit.
• Loss is the amount of money by which a business's costs exceed its revenues.
• The average rate of return (ARR) is the average annual return (profit) from an investment.
• Break-even is the level of output at which revenues from sales equal total costs. It is the number of units a firm has to produce and sell to recover its total costs.

The following are examples of basic financial terms:

1. Revenue

• operating revenue
• non-operating revenue

2. Cost

• fixed costs
• variable costs
• semi-variable costs
• total costs

3. Profit

• gross profit
• net profit

Total cost is the total expenditure of a business over a time period.

Total cost = Total fixed costs + Total variable costs

Variable costs are those costs that change as per the performance and output of the business.

Fixed costs are costs that are independent of business performance.

Revenue is money that a business receives from selling its goods or services.

Revenue = Number of units sold x Cost per unit

## Final Financial Terms and Calculations Quiz

Question

Revenue is

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Question

The formula for calculating revenue is

Revenue = number of units sold * selling price

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Question

Two types of revenue are

Operating and non-operating revenue

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Question

If a company made a loss of £50000 and their operating cost was £90000 in the year 2020, calculate the revenue.

£40000

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Revenue is shown on which finiancial document?

Income statement

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What is non-operating revenue?

1. Company may earn revenue from other sources like renting out properties, dividends, profit, or loss from investments. Non-operating revenue includes everything other than revenue from primary streams.

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Question

Revenue of Netflix from monthly subscription is a ______type of revenue.

Recurring

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Question

Companies with revenue between 10 million to 1 billion are called as

Small and mid-sized enterprises (SME)

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What is the formula for calculating operating revenue?

Operating revenue = number of units sold * selling price

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What is the difference between revenue and profit?

Profit = Revenue – total cost

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Question

If revenue = total cost, then the business is in

break-even

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Question

Small and mid-sized businesses have annual revenue of _____

less than or equal to $10 million. Show question Question A fare paid to the taxi driver is ____type of revenue for taxi company. Show answer Answer Service based Show question Question For a landlord, a revenue earned via rents collected is ____type of revenue. Show answer Answer Recurring revenue Show question Question A company sold 50 toys every month for a year. The average price of each toy was$10. What is the revenue of that company at the end of the year?

\$6000

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What are fixed costs?

The costs that are independent of business performance are called fixed costs.

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What are variable costs?

The cost that changes as per the performance of the business is called variable costs.

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What are semi-variable costs?

The cost that changes when there is a large change in the output is a semi-variable cost. For example, buying new machinery or opening an e-commerce website are semi-variable costs.

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What is the total cost?

Total cost is an expenditure of business over a time period.

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Total cost is the sum of _____.

Total cost is the sum of fixed costs and variable costs.

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Profit or loss = Revenue – ________.

Profit or loss = Revenue – Total cost

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If the total revenue of the business is equal to the total cost, then the business has achieved a break-even.

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What are economies of scale?

Economies of scale occur when the cost per unit decreases if the production increases.

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What is diseconomies of scale?

When the cost per unit increases with the increase in production, is called diseconomies of scale

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What is the external cost?

The environmental consequences of business activities are called external costs. External costs affect people who are not directly involved in production.

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How does cost impact the location of business?

Businesses have to decide on how much rent they can afford, before choosing the location. Sole traders may start their business at home to save costs or restaurants choose to pay high costs for a premium location to attract customers.

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Question

Mention any two ways to reduce cost.

Ways to reduce costs are:

1. Reducing the cost of raw materials:
2. Reducing labor costs:
3. Reduce fixed costs:
4. Product redesign:
5. Just-in-time or just-in-case approach:

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What is the just-in-time and just-in-case approach?

Just-in-time means ordering stocks when needed and the just-in-case approach is keeping stocks if in case there is a shortage.

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What is profit?

Profit is money that a business makes after all costs have been subtracted from the revenue.

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What is a profit formula?

Profit = Revenue - Costs

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Profit and revenue are the same thing.

False

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What is revenue?

Revenue is money that a business receives after selling its goods or services.

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What is the difference between profit and revenue?

The difference between revenue and profit is that revenue does not consider costs incurred by a business whereas profit does.

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What are the two types of profit?

• Gross profit
• Net profit

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Which financial statement can we find gross profit and net profit in?

Income statement

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What is gross profit?

Gross profit is the profit made by a business after subtracting all the costs related to manufacturing and selling its products.

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What is the gross profit formula?

Gross profit = Revenue - Cost of products sold

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What is net profit?

Net profit is the profit made by a business after all of its expenses have been subtracted from revenues. These expenses include costs related to manufacturing and selling products, interest, taxes and any other expenses.

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What is the net profit formula?

Net profit = Revenue - All costs

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What is the difference between gross profit and net profit?

The difference between gross profit and net profit is that gross profit excludes costs related to manufacturing and selling products whereas net profit excludes all the expenses.

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What is the income statement and what does it show?

The income statement shows the profit earned and loss sustained by a business over a particular period (usually 12 months). It shows all revenues earned and expenses incurred during the specified period.

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The value of which figure is lower?

Net profit

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Define cost.

Cost is money a company has spent to operate.

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Define loss.

Loss is the amount of money by which a business's costs exceed revenues.

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Define revenue.

Revenue is money that a business receives after selling its goods or services.

Show question

Question

Which financial statement can we find a revenue figure on?

Income statement

Show question

Question

What is the income statement?

The income statement shows the profit earned and loss sustained by a business over a particular period (usually 12 months). It shows all revenues earned and expenses incurred during the specified period.

Show question

Question

What are the two types of revenue?

• Operating revenue
• Non-operating revenue

Show question

Question

What is the operating revenue formula?

Operating revenue = Number of units sold x selling price

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Question

Define cost.

Cost, in other words expense, is money that a business spends to operate.

Show question

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