Revenue vs. Profit vs. Cash Flow – Know the Danger
So what’s the difference between revenue, profit and cash flow and why should you care? Well, if any of the three are out of whack, your business is in trouble. Before we get into the dangers, let’s take a look at the difference between the three.
Revenue refers to the income your business has earned from the sale of your goods and services. Your revenue may also include money earned from other sources, such as interest, fees and royalties. Revenue is generally described in terms of a specific time period, such as revenue in a particular month, quarter or year.
For instance, if a service company invoiced $100,000 in March, then they have earned revenue of $100,000 for that month. In this case, the business is not receiving payment in actual cash, rather it is ‘owed’ $100,000. In accounting terms, once they’ve invoiced a customer the amount is considered revenue.
A business may have revenue in a given time period that includes invoices they have sent out to customers, as well as cash payments that have been made at the time of a purchase. All of these sales are included as revenue during that time period.
If you were referring to your Income Statement from the month of March, the top line of that statement would contain the $100,000 in revenue.
The term ‘revenue’ is commonly used in business in other situations. For instance, you may say that you’ve earned more revenue from the sales of a specific product vs. another. You may also ask what revenue was earned for a particular contract or from a specific customer. In these cases, revenue refers to the income or earnings in each situation but may not refer to a particular timeframe. ‘Revenue’ never accounts for expenses and costs. It simply describes total money earned by the business.
So, if you had a single contract to perform a service for a customer and the contract was worth $50,000, then your revenue for the project was $50,000.
In the simplest terms, profit is the result of your revenue minus your expenses.
So, earning a profit means that you’ve made more money than it costs to deliver the goods or services. In our revenue example above, the single contract was worth $50,000. If it cost your business $40,000 to provide that service, the resulting profit on the contract would be $10,000.
Going a little more in-depth, there are two types of profit. Gross profit and net profit. These two figures are used in determining your gross profit margin and your net profit margin.
Your ‘gross profit’ calculates the revenue from your goods or services minus the cost of those goods or services (COGS). It’s important to note that your gross profit only accounts for expenses directly related to the creation of those specific goods and services.
Your net profit differs from gross profit in that it includes all other business expenses, not just the direct costs. The additional expenses include costs, such as payroll, utilities and taxes.
Cash flow is the amount and timing of the payments you receive and the expenses that you pay. Specifically, when the money is actually deposited into your bank account or given to you as cash it can be counted as an inflow in your cash flow. When you pay for an expense and the money leaves your bank account or you pay an expense in the form of cash you have on hand, that money is counted as an outflow in your cash flow on that specific day.
Here’s where things often get tricky for businesses. In the case of our example contract where we have $50,000 in revenue, let’s say you will be paid in two stages of $25,000 dollars each. You send out the first invoice at the start of the contract and expect to paid in 30 days. You send out the second invoice a month later so your are expecting that payment in 30 days from the invoice date.
Assuming that you receive the money in your hand or deposit in your bank account on the exact due date you will have a cash inflow 30 day from the start of the project and the additional $25,000 60 days after the beginning of the project. You will need to have some way to keep your business running, pay staff and expenses to until you receive those payments.
That’s your cash flow: the amount and the timing of the payments to and from your business.
More than ever small business owners need to find ways to manage and forecast their cash flow. As you can see from the example above, things can get complicated pretty quickly and that’s where we’ve found cashflow forecasting software can help.
Revenue, Profit and Cash Flow Conundrum
It can be easy to focus on a single core metric to evaluate the health of your business but that could be to your detriment. Any one of these three cornerstones can cause you a significant headache, if not kill business, if they aren’t all in line.
Many businesses have been caught in this cash flow crunch. They’ve focused too much on the revenue and not enough on understanding when the actual cash will land in their bank account and become available for paying expenses.
Likewise, profit margins can become very slim when companies bid against each other and the lowest price often wins the contract, when productivity dips or expenses are higher than predicted. Some revenue may be better than none when bills keep piling up but, unfortunately, when it costs more than expected to deliver, companies end up taking a loss. Too many unprofitable sales will sink a company.
Finally, companies can sometimes believe they are financially healthy when their cash flow is strong and projects are profitable. Money is flowing in the doors and staff are busy. But if they haven’t kept their sales pipeline full with new revenue, they may end up with staff sitting idle and not enough money over the long term to stay in business.
So, in the end, make sure you track your expected sales revenue, profit margin and maintain your cash flow projections on an ongoing basis. All three are critical for a healthy, growing business. In talking with small business owners, we’ve found that an online forecasting tool can help you with tracking these important numbers so you can be proactive in growing a small business.
Dryrun can help you take hold of your cash flow, predict your sales pipeline and analyze your profit.