Revenue, Costs & Profit
Two Streams of Money in Every Business
Two streams of numbers run through every business: money going out (costs) and money coming in (revenue). What’s left after costs have been taken off revenue is profit. If costs are greater than revenue, the business makes a loss.
Understanding the different kinds of cost is the key to nearly every Finance question in the exam. A business that cannot tell which costs are fixed and which are variable cannot set prices sensibly, cannot work out break-even, and cannot forecast what happens to profit if sales rise or fall.
Fixed, Variable and Total Costs
Fixed costs stay the same whether the business makes 10 units or 10,000. Rent, salaries of managers, insurance and business rates are classic examples. A coffee shop pays the same rent whether it sells one latte a day or a thousand.
Variable costs rise and fall with output. Every latte needs coffee beans, milk and a cup — sell twice as many, and those costs double.
Total costs are simply fixed costs plus variable costs for a given level of output:
$$\text{Total costs} = \text{Fixed costs} + \text{Variable costs}$$
Fixed costs stay the same when output changes (rent, salaries, insurance). Variable costs change directly with output (raw materials, packaging, hourly wages). Total costs = fixed + variable.
Revenue
Revenue (sometimes called turnover or sales) is the money coming in from selling products or services. The formula is straightforward:
$$\text{Revenue} = \text{Price per unit} \times \text{Quantity sold}$$
Revenue is not profit. It is the gross figure before any costs are deducted. A business with £1 million in revenue may be making a loss if its costs are £1.2 million.
Worked Example — Oakleaf Coffee
Imagine a fictional UK coffee shop, Oakleaf Coffee. It sells a latte for £3.50. In one week it sells 800 lattes. Its fixed costs (rent, manager’s salary, insurance) are £1,200 per week, and variable costs (beans, milk, cups, hourly staff) are £1.10 per latte.
Step 1 — revenue:
$$\text{Revenue} = \pounds3.50 \times 800 = \pounds2{,}800$$
Step 2 — total variable costs:
$$\text{Variable costs} = \pounds1.10 \times 800 = \pounds880$$
Step 3 — total costs:
$$\text{Total costs} = \pounds1{,}200 + \pounds880 = \pounds2{,}080$$
Step 4 — profit:
$$\text{Profit} = \pounds2{,}800 - \pounds2{,}080 = \pounds720$$
Oakleaf makes £720 profit that week. If sales dropped to 400 lattes, variable costs would fall to £440 but fixed costs stay at £1,200. Revenue would be only £1,400, and the shop would lose £240. This is why the split between fixed and variable costs matters so much — it tells you how sensitive profit is to a change in sales.
Gross Profit and Net Profit
OCR distinguishes between two kinds of profit. Gross profit measures how much a business makes after paying for the goods it sold. Net profit goes further and takes off every other cost too — rent, utilities, salaries, interest.
$$\text{Gross profit} = \text{Revenue} - \text{Cost of sales}$$
$$\text{Net profit} = \text{Gross profit} - \text{Other expenses}$$
A small clothing shop has annual revenue of £200,000. The cost of the clothes it bought from suppliers (cost of sales) was £120,000. Its other expenses — rent, utilities, shop assistant wages, insurance — totalled £50,000.
Gross profit = £200,000 − £120,000 = £80,000.
Net profit = £80,000 − £50,000 = £30,000.
The business is profitable both gross and net. But if rent rose by £20,000 and other expenses jumped to £70,000, net profit would fall to £10,000 even though gross profit stayed at £80,000. Net profit is always the more cautious figure — and the one investors care about most.
Gross profit = Revenue − Cost of sales. Net profit = Gross profit − Other expenses. Gross profit shows how much the products themselves earn; net profit shows what’s left after every cost of running the business.
High fixed costs, low variable costs — think of a cinema. The building, projector and staff salaries are expensive, but each extra viewer costs almost nothing. Once fixed costs are covered, every extra ticket sold is nearly pure profit. But if attendance drops, the huge fixed costs still have to be paid.
Low fixed costs, high variable costs — think of a market-stall sandwich seller. Stall rent is low, but bread, fillings and packaging cost real money per sandwich. Profit per unit is smaller but the business is far less risky in a quiet week.
Why These Numbers Drive Decisions
Understanding revenue, costs and profit is not just an accounting exercise. Managers use these figures every single day: to set prices sensibly (variable cost per unit plus a margin that covers fixed costs), to spot problems early (rising costs with flat revenue means trouble ahead), to talk credibly to lenders and investors (banks want to see strong, steady profit before agreeing to a loan), and to decide which product lines to keep and which to drop. A business that cannot explain its own numbers in a meeting is unlikely to walk out of a bank with the loan it needs.
The same logic applies to small businesses too. A newsagent tracking daily sales against weekly rent, wages and stock costs knows within minutes whether Tuesday was profitable. Scale the principle up and you have the dashboard every UK PLC relies on: Tesco, Greggs and Next all publish revenue, cost of sales, gross profit and net profit figures to their shareholders every six months, using the same basic formulas taught here.