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Turnover and profit are two of the most important accountancy terms that anyone running a business (or any other entity involving finances) will come across. They sound similar but mean very different things; and to make matters more confusing, they are sometimes called by other names.
What is turnover?
Turnover (also known as revenue or sales) is the money the business brings in from its trading activities. In most businesses this is from the sale of goods and/or services, but it can also mean income from other activities such as rental of assets, licensing agreements, commissions, or interest on business bank accounts.
The key point is that turnover is the total amount coming in before any costs are taken away. It shows the scale of activity, but not how much you actually keep.
What is profit?
Profit (sometimes called earnings) is the amount left once all allowable business costs are deducted from turnover. These costs can include materials, wages, rent, utilities, marketing, professional fees, loan interest, and anything else necessary to keep the business running.
There are different types of profit; gross profit is turnover minus the direct costs of producing goods or services. Operating profit takes away other running costs such as administration, and net profit is what remains after every expense, including tax.
Net profit is usually the clearest measure of what the business has earned after costs.
The difference between turnover and profit
Turnover is the total inflow of money; profit is the amount you keep. A business can have a large turnover but still make very little profit if expenses are high. Some businesses may even operate at a loss and continue trading if it has access to reserves, external funding, or finance. This can happen in start-ups or during planned growth, where building capacity is prioritised over immediate profit.
Do you pay tax on turnover or profit?
This is one of the most important accountancy rules. Tax is calculated on profit, not turnover. Allowable expenses reduce your profit and therefore reduce the tax you need to pay. Many businesses aim to maximise the number of legitimate expenses claimed to keep their tax liability low, although there are times when showing a higher profit is more beneficial.
Examples of turnover and profit in businesses
Spark Electrical Services is a sole trader electrical contracting business with an annual turnover of £95,000.
Its allowable expenses total £62,000, including tools, van lease payments, fuel, protective clothing, insurance, advertising and accountancy fees.
This leaves a profit of £33,000.
Tax is calculated on £33,000, not the full £95,000.
Strong Engineering Ltd is a medium-sized manufacturing company with a turnover of £2.4 million.
Its allowable expenses, including raw materials, wages, factory rent, machinery servicing, energy costs, transport and professional services, total £2.38 million.
This leaves a profit of just £20,000 – less than Spark Electrical Services despite having a far higher turnover.
The difference lies in the running costs, which in Strong Engineering’s case consume almost all of its income.
To support growth and manage taxable profit, Strong Engineering will invest in new staff to increase production capacity and meet demand.
If I’ll pay more tax, why would I choose to run a higher profit?
From what we’ve spoken about, it would be reasonable to assume you will always want to reduce your profit to reduce your tax bill.
And whilst this is sometimes the case, it’s important to know that there are situations where you may want to show a larger profit on your accounts.
For example:
- If you are personally applying for, or planning to apply for, a mortgage or remortgage, where lenders will review your declared income (as a sole trader) or company profits (as a limited company).
- If you’re seeking business loans or credit, as lenders often require proof of strong and consistent profitability.
- If you are looking to attract investors or to sell the business, higher profits can increase your valuation.
- If you’re tendering for contracts that require financial strength to be demonstrated.
- If you need to meet covenant requirements with existing lenders or investors.
In these cases, the short-term cost of an increased tax bill may be outweighed by the long-term advantages of showing a stronger profit.
Common misconceptions about turnover and profit
A high turnover always means a high profit
As we’ve shown in the examples above, this isn’t always the case. Spark Electrical Services had a lower turnover than Strong Engineering Ltd but their profit was higher because of their lower running costs.
Tax is based on the total income without deductions
This isn’t the case. Both Spark Electrical Services and Strong Engineering Ltd pay tax on their profits, not on turnover. For Spark this means tax is based on £33,000, and for Strong it is based on £20,000. In many cases, an accountant will look for legitimate opportunities to reduce a business’s tax bill, although there may be situations where a higher profit is desirable.
A business with low or no profit cannot continue to trade
No, in fact it is quite common for a business to operate at low or no profit. A business like Strong Engineering Ltd could continue operating with small profits or even a temporary loss if it has reserves, investment, or finance.
This can be part of a growth strategy, where profits are kept low while the business reinvests in staff, equipment, or facilities. However, this does come with a caveat: if something happens that disrupts the business such as major changes to the economy, a drop in demand, a sharp rise in costs, or the loss of a key client, the business could quickly face cash flow problems and operate at an unsustainable loss.
We’re here to help
If you need help understanding your figures, working out your profit or what you can claim as a business expense, we can help.
We’ve worked with sole traders, company directors, and small businesses across East Anglia for over 100 years to make sure accounts are accurate and tax bills are under control.
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