When you run a business, you need to understand the two most crucial metrics that indicate a company’s performance–revenue and profit. Though both the terms are very different from each other in their applications and measurement, the two concepts often get interchanged in their usage. This becomes a problem when it comes to applying for a business loan as many entrepreneurs make the mistake of confusing annual revenue with gross profit. Every business owner needs to grasp the distinction between these two concepts to get an accurate reporting of their business’s financial performance, especially if you are seeking funding. Any mistake in understanding the metrics can not only derail your loan application but could also lead to rejection.
This article will explain the difference between annual revenue and gross profit, share insights into why lenders look at these metrics and provide tips on how to accurately track and report them when applying for loans.
What Is Annual Revenue?
Let’s begin by defining annual revenue. In simple terms, it means the total amount of money that your business makes in a 12-month period from sales of product and services before any expenditures are deducted. It is often referred to as ‘sales’ on income statements.
Annual revenue is an import metric to assess a business’s performance as it provides an overview of your company’s earning capacity. For example, if you are applying for a funding, a lender is bound to check your gross annual revenue to assess your business’s ability to repay the loan. The more revenue you make, the possibility of your qualifying for a larger loan goes higher.
Important Factors That Influence Annual Revenue:
Annual revenue of a company is shaped by three major factors –quantity of sales (sales volume), how much you charge (pricing) and how well can you keep your customers coming back to you (customer retention).
- Sales Volume: This refers to the number of products or services that a business sells within a given period. The more products you sell, higher will be your annual revenue.
- Pricing: This means pricing of your products/services. There needs to be a balance while deciding on the product pricing. This is because while higher prices might increase the revenue even with constant sales volume, you might also lose customers, which might bring down the revenue. But lower pricing might increase sales but revenue per sale might be less, which in turn can affect the overall earning adversely. So, entrepreneurs need to find a balance to maintain their profitability.
- Customer Retention: It simply refers to how well your company retains its existing customers. It is important because loyal customers contribute a large portion to recurring revenue streams, such as annual recurring revenue. It can significantly impact your total income.
What Is Gross Profit?
Gross profit is a more specific metric as it is an indicator of profitability. It refers to the income left after subtracting the cost of goods sold (COGS) from the revenue. All direct costs linked to producing the products/services offered by the company come under COGS, such as materials, labor and manufacturing expenses.
Gross profit also shows how efficiently your business is converting revenue into actual earnings. Unlike annual revenue, which covers only the total earnings, gross profit provides insight into the actual financial health of your business after covering operational costs.
Why the Difference Matters for Your Loan Application
It is of utmost importance that you understand the distinction between annual revenue and gross profit when applying for a loan because lenders check both metrics to evaluate your eligibility. If any of these figures are incorrect or misleading, it could lead to loan rejection.
Here’s why lenders care about both metrics:
1. Annual Revenue as a Measure of Scale
Your annual revenue can help lenders assess the scale and size of your business. Higher revenue might imply a greater capacity to repay larger loans and consistent income streams that can cover loan repayments.
2. Gross Profit as a Measure of Profitability
A business’s gross profit indicates how much of the revenue actually stays in the company after taking into account all the production cost. If your business generates high annual revenue but a low gross profit margin, it may spell trouble for your loan application as it may signal inefficiencies. Lenders may assume that you will struggle to repay, especially if a large part of your revenue is spent on operational costs.
3. Misreporting Can Lead to Loan Rejection
A lot of entrepreneurs get confused between annual revenue and gross profit. Misreporting on either metrics can skew the numbers in your loan application, which might lead to rejection.
Tips for Accurate Financial Reporting
To improve your chances of securing a loan, it’s crucial to report both annual revenue and gross profit accurately. Here are some best practices:
1. Use Accounting Software
Reliable accounting software can help you track gross annual revenue, COGS and profit margins. So, investing in such software will ensure that you are accurately reporting the correct numbers to the lenders.
2. Consult a Financial Expert
If your confusion between annual revenue and gross profit become overwhelming, it is wise to consult with an accountant or financial adviser for clarity. They can help you accurate financial statements, which are crucial for loan applications.
3. Regularly Review Financial Reports
Regularly monitor your financial statements to ensure that your revenue and profit figures are accurate. Misreporting or sharing outdated information can lead to complications when applying for a loan.
Conclusion
It is vital that you clearly understand the difference between annual revenue and gross profit, not just for running your business but for successfully applying for a loan. Both metrics offer important insights into how well you are managing your business’s operational costs, performance and financial health. This is why lenders take a hard look at both these metrics and any mistake in reporting can seriously damage your chances of securing a loan.