Small Business Financial Article

When starting out, most small businesses’ sole focus is to generate revenues as quickly as possible. Revenues, which are also referred to as "sales," are critical to a small business trying to gain a foothold in the market. At some point, however, the business will need to generate profits if it is going to stay in business. A business can have growing revenues each month, but it will have a tough time growing if it can’t generate them profitably. That illustrates the critical distinction between revenue, money your business receives, and profits, which is left over after your business covers all the costs.

Finally, cash flow is the lifeblood of your business, without which it could go into cardiac arrest. It’s possible to have strong revenue growth and even show a profit each month, but the business could still starve itself without a steady stream of cash flow. Revenue, profits, and cash flow, although interrelated, are vastly different in terms of their impact on your business and how you manage your business.

Breaking Down Revenue, Profits, and Cash Flow

Revenue

Revenue is what your business earns from the sale of its goods or services. Your business can also generate un-earned revenue from interest, fees, and royalties. Assuming most of your revenue comes from the sale of products or services, it is generally recorded as invoiced or as received in cash payments. If you invoice a customer for $10,000 of products, that is recorded as revenue. At the end of the month or quarter, or year, your revenue is recorded at the top of the line on your income statement before expenses and costs.

Profits

At its core, profits are what is left over after subtracting the expenses incurred for producing the revenue. If it took $7,000 to produce $10,000 in goods sold, your profit is $3,000. However, it goes a little deeper than that because you will need to calculate both "gross profit" and "net profit" to have a clearer picture of how your business is doing.

Gross Profit: Revenue minus the direct cost of producing the goods and service is gross profit.

Net Profit: Revenue minus direct cost of producing goods and services minus all other business expenses (i.e., payroll, rent, utilities, taxes).

Gross profit tells you how efficiently your business is producing the products and whether they are priced appropriately. Net profit is your bottom-line result of what the company has left over to invest in the company.

Cash Flow

Cash flow is the amount of money your business has on hand at any time resulting from inflows and outflows occurring each day. If you invoice a customer for payment in 30 days, you will have generated revenue, but you won’t have cash flow from the transaction for a month. That is why managing cash flow, which includes receivables and payables, is critical to ensuring you have sufficient cash on hand to pay the bills.

What Your Income Statement Tells You

Each day your business executes a number of transactions – bills are paid, money is received – creating a flurry of activity that makes it difficult to know where you stand. The income statement, which is prepared monthly, quarterly, and annually, tells you how you are doing within a specified period of time. This will tell you if your revenue or sales are trending up or down. It will also tell you how much money is left at the end of the period after deducting all costs. More importantly, the income statement tells you how much money you have to pay down debt and grow the business.

What the Cash Flow Statement Tells You

The cash flow statement tells you exactly how much money is coming in and going out of the business and how much is on hand to pay daily expenses and immediate debt obligations. It will inform you of your working capital needs in anticipation of increasing sales when additional material or labor is needed. It can reveal any deficiencies your business has in generating and maintaining cash so you can work with to overcome them.

Generally, ratios are not used for analyzing your cash flow statement, which is more of a bottom-line calculation of how much cash you have or will have in the near future.

Summary

Revenue, profits, and cash flow are all key indicators of how well your business is doing. In terms of managing your business for growth, one is no more important than the other because they must work in sync for sustainable growth. It may all start with revenue but managing productivity and pricing for profits and managing cash flow to pay the bills are equally critical for long-term success.