4 Reasons Your Revenue Is Increasing While Profit Is Decreasing

by | Jun 8, 2022 | Accounting

As the owner of a service-based business, one of your goals is undoubtedly to increase revenue. Increased revenue often leads to increased profits, but there are situations where increasing revenue may cause profits to decline. In this article, we will discuss four reasons revenue is increasing while profit is decreasing.

 

Revenue and Profit Basics

It is helpful to get a baseline understanding of the relationship between revenue and profit. Revenue is what your service-based business receives as payment for services provided, while profit consists of revenue minus all your expenses for the corresponding period.  

For example, suppose in January your company provided services that generated $20,000 in revenue. You calculated January’s business expenses to be $8,000. Subtracting expenses from your revenue leaves you $12,000 in profit for the month. 

You can tell from this discussion that expenses, or costs, play a key role in how much profit your service-based business generates. Let’s look at costs more closely.

 

Fixed Costs/Expenses

Costs are one of the biggest reasons your company’s revenue is increasing while profit is decreasing.

Fixed costs are costs that do not change with the level of business activity. Examples of fixed costs are rent, loan payments, and salaries.

Variable costs are costs that do change as activity levels change. Some examples of variable costs are materials, hourly labor, and sales commissions. 

For example, suppose your rent and loan payment in the above example was $5,000 for January, and your hourly workers earned $3,000. The $5,000 fixed expense added to the $3,000 variable equals your total monthly expense of $8,000.

Separating fixed and variable expenses is important as it can help narrow down areas where costs may be running higher than expected or budgeted. 

Reasons Why Revenue is Increasing and Profit is Decreasing

Expense/Cost Increases

Costs coming in higher than expected is one of the biggest reasons your service-based business’s revenue is increasing while profit is decreasing. This can be due to internal or external factors. 

For example, suppose your company requires a significant amount of cleaning supplies to properly complete services. Due to a shortage in a certain material, the price of cleaning supplies has gone up 50%. In this situation, the extra cost of a needed supply is caused by an external factor. 

Similarly, if you decide to give your company’s floor manager a 5% raise due to good performance the previous year. The increase in salary is an internal factor that increases your company’s salary expense. 

Both external and internal factors that increase costs will reduce your company’s profit, and are major reasons why your revenue is increasing while profit is decreasing.  

 

Customer Acquisition Costs

It seems intuitive that acquiring new customers will generate more revenue, and therefore more profit. However, this is not always the case. There is often a cost associated with acquiring new customers, and these costs are another reason why your revenue is increasing while profit is decreasing.

For example, suppose the total cost to acquire a new customer is $100. Each new customer brings in $80 of revenue. In this situation, you can see that although your revenue is going up by $80 for each new customer you acquire, your costs are increasing at a higher rate.

This is important as many service-based businesses either do not include customer acquisition costs in their expense calculations, or do not account for them correctly. Not accounting for these costs will unfortunately result in inaccurate financial statements and a profit number that is higher than actual. 

 

One-Time Costs

One-time costs are another reason why your revenue is increasing while profit is decreasing. Unexpected costs include repairs due to a weather emergency, severance for departing employees, and similar situations.

Although these costs do not repeat, it is important to track them accurately as one-time costs are a major reason your revenue is increasing while profit is decreasing. 

 

Incorrect Service Mix

Like manufacturing companies, service-based businesses need to utilize a service mix that yields acceptable profit margins.

For example, suppose you run a cleaning company and offer both residential and office cleaning. You realize that your office cleaning services make up 80% of your revenue, but you only allocate 50% of company labor to office cleanings.

By allocating more labor to office cleanings, your company can utilize a more profitable service mix and avoid one of the main reasons why your revenue is increasing while profit is decreasing.

 

We hope this article has given you a glimpse into some of the main reasons why your service-based business’s revenue is increasing while profit is decreasing. An important overall point to keep in mind is that maintaining an accurate and up to date set of accounting books is the backbone of making appropriate revenue and profit decisions.  

 

For more information on how we can help your company increase margins and the effectiveness and efficiency of operations, be sure to check out the rest of the North Shore Accounting website!