As a business owner, seeing a lot of revenue can be an exciting experience. It's easy to fall into the trap of believing that a high amount of revenue automatically means that the business is profitable. After all, the more money a business brings in, the more successful it must be, right? Not always.
It's essential for business owners to understand that revenue, profit, and cash flow are all different indicators of a company's financial health. In reality, it's possible for a business to have high revenue, and still not be profitable. In this blog post, we'll explore the differences between cash flow, revenue, and profit and why it's important to understand each one.
Cash Flow: What Keeps Business Thriving
Cashflow is the amount of cash that flows in and out of a business over a certain period of time. Positive cash flow means that a business is bringing in more money than it's spending, while negative cash flow means that a business is spending more money than it's bringing in.
Cash flow is critical for the day-to-day operations of a business, as it determines whether the business has enough cash to pay its bills and cover its expenses. It is also an important metric for measuring a business's liquidity because it shows how much cash a business has on hand to pay its bills and invest in its future growth.
Revenue: What Fuels Growth
Revenue is the total amount of money that a business brings in from sales or other sources. It represents the inflow of funds into a company from its customers or clients. It's the top line on a company's income statement, and it doesn't account for any expenses or other costs associated with running the business.
Revenue can come from various sources such as selling products, rendering services, or from investment income. It is a key financial metric that indicates the overall financial performance of a business and its ability to generate income, invest in growth, and generate profits.
Profit: Success Realized
Profit, on the other hand, is the amount of money that a business makes after accounting for all expenses, including salaries, rent, materials, and other costs. It's the bottom-line number that represents the true profitability of a business.
There are different types of profit metrics, such as gross profit, operating profit, and net profit, each representing a different level of analysis of the business's financial statements. However, they all represent the same concept - the amount of money a business is earning after subtracting all expenses.
How Cash Flow, Revenue, and Profit Affect Each Other
It is important to understand that a business may have a high revenue number, but if its expenses are also high, it may not be profitable. For example, a business that generates $1 million in revenue may not be profitable if its expenses are $1.2 million.
Similarly, a business may have a lot of revenue and be profitable on paper, but if it doesn't have enough cash on hand to pay its bills and expenses, it may still face financial difficulties. A positive cash flow is critical for a business's survival, and it's important to ensure that the business has enough cash on hand to cover its expenses, even during slow sales periods.
For example, a business that has high revenue and profits, but still has poor cash flow because customers aren't paying their invoices on time and because the business is carrying too much inventory. In this case, the business may have to take out loans or use its credit line to pay its bills, which can lead to cashflow problems down the road.
On the other hand, profit is calculated by accounting for payments you have received and your accounts receivable and accounts payable. For example, your business can be cash negative but profitable because you are waiting for a hefty invoice to be paid.
While revenue is a critical metric for measuring a business's growth and success, it's not an accurate indicator of profitability. Profit, on the other hand, is a more accurate metric for measuring a business's financial health because it takes into account all of the costs associated with running the business. Cash Flow is also an important metric because it shows how much cash a business has on hand to pay its bills and invest in its future growth.
Business owners need to understand the differences between revenue, profit, and cash flow to ensure that they're accurately getting a complete picture of their company’s financial health. They need to track their revenue, expenses, and profit margins closely and regularly review their cash flow to ensure that they're not spending more than they're bringing in. By doing so, they can make informed decisions about their business's growth and invest in projects that will help them achieve long-term success.
Fight 'Feast or Famine’
Model the future of your cash flow, sales and scenarios in a single source of truth, to smooth out your revenue and achieve a steady stream of income.
Spot the peaks and valleys ahead of time so that you can adjust your capacity, backfill sales, and pick and choose the best projects, generating more money with the same team.