Wednesday, 8 August 2012

Revenue v. profit for dummies*

Dave is the sole director and owner of 100% of the shares of Dave's Widgets Limited which employs him and two other people. In 2010, he sold £100,000 of widgets. That was his revenue (also known as sales or turnover). Now there are costs involved with making widgets. For 2010, these were:

Raw materials - £20,000
Rent - £5,000
Utilities (power, water, etc.) - £2,000
Sales/marketing - £3,000
Staff salaries - £30,000
Dave's salary - £20,000
Total - £80,000

Deducting the above from the revenue figure gives you £20,000. That's Dave's operating profit or earnings before interest and tax (EBIT). Since this is simple example, we'll forget about interest and look at tax. In the UK, corporation tax would be due at a rate of 20% on this £20,000, so £4,000. Take that away from the £20,000 leaves £16,000, the net profit.

Fast forward to 2011 and there's a shortage of raw materials, the landlord is being an arsehole, gas and electricity have gone up yet again, and a campaign to bring in more sales didn't work and revenue remains static at £100,000. Overall costs are now as follows:

Raw materials - £30,000
Rent - £10,000
Utilities (power, water, etc.) - £4,000
Sales/marketing - £6,000
Staff salaries - £30,000
Dave's salary - £20,000
Total - £100,000

Now Dave has no operating profit and therefore nothing to tax. Corporation tax due is zero. So what's my point? Well the examples above demonstrate the difference between revenue and profit and that a company's revenue has no bearing on corporation tax that it may or may not pay.

This blog post is in response to an article in the Telegraph today with its failings covered nicely by FCA Blog. There's also a still incorrect but slightly less mangled version of the article here.

* UK Uncut, Occupy, and Matt Warman.

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