Why Are Cost, Revenue & Profit Important?

Why Are Cost, Revenue & Profit Important?

Cost, revenue and profit are the three most important factors in determining the success of your business. A business can have high revenue, but if the costs are higher, it will show no profit and is destined to go out of business when available capital runs out. Managing costs and revenue to maximize profit is key for any entrepreneur.

Definition of Terms
Revenue is the same as total income for a business and measures all money taken in through sales of goods and services. Cost measures the total expenditures made by the business to run the operation: both the "direct" costs involved in creating the goods or services, as well as the "indirect" costs that stem from running a business, such as rent, salaries and legal or professional fees. Profit is the total revenue minus the total cost; this is the money made by the business and is the key indicator of success.

Revenues vs. Profit
Many businesses are judged on the basis of revenues, not profit. For example, an Internet start-up may show high revenues even in the early stages of the business but will typically spend far more money than total revenue on business expansion and marketing. This is only possible when investors are available to provide additional capital -- the term for investment money provided to the business -- that allows it to spend more money than it brings in. In the long run, a business that requires constant investment will fail; only a profitable business will be able to pay back its investors. Sometimes, however, an entrepreneur may be able to personally succeed if he can sell his business while it is unprofitable, if investors believe the chance of future profitability is high. In most cases, however, only profitable businesses can be sold at reasonable prices to new owners.

Cost Reduction
Everything a business spends money on is a cost, and many businesses attempt to increase their profitability by reducing costs. There are many sound ways to do this; for example, a retail business can expand by starting additional stores or can take the much cheaper option of starting an online business to complement its brick-and-mortar operation. However, some methods of reducing costs will be damaging to the business: Pay your employees too little or reduce your staff too much, and you will be unable to handle enough sales to generate future profits.

Profit Measurement
Good entrepreneurs measure their profitability very frequently, perhaps on a daily basis. All goods sold must be priced high enough above cost to pay for the direct costs spent to acquire or create the good, as well as their share of overall indirect costs. When costs of goods increase, their price must increase as well, or the product must be dropped from the product line. A strong business may offer regular sales or bargain pricing to move customers into the stores, but no business can survive if the pricing of individual goods or services does not consistently return profits back into the business.