There is a saying: “it takes money to make money.” How do you know if you are making money? And will you have money next month? In this blog post, I discuss the difference between revenue, profit and cash flow.
Revenue, also called sales or income, is the gross amount invoiced to customers or clients.
Increasing revenue is one sign of a healthy, growing business, but not the whole picture. Selling more of an unprofitable product is generally a bad idea.
Salespeople focus on revenue.
Profit is better than revenue, because profit includes the effect of expenses. Profit provides a better picture of the success of your business and your overall ability to keep costs down and grow revenue.
If your revenue is increasing but your profit is dropping or negative, something may be wrong. Review how much money you are spending on customer acquisition, overheads, and product/service delivery costs compared to your revenue.
Larger corporate businesses, and their investors and lenders, often focus on profit.
Owners of small-to-medium businesses (should!) focus on cash flow, especially if their business is growing.
Cash flow is best because it is the major indicator of the ongoing health of the business. Without positive cash flow, a business will eventually run out of money and close.
Cash flow is also a more ‘real’ result than profit. A business can show profit but still be forced to close if there is no cash to pay suppliers, staff or lenders.
The differences between profit and cash flow are usually hiding on the Balance Sheet, for example:
- Accounts receivable or debtors: when a sale to a customer is recorded as revenue before the customer pays, that increases the business’ profit but not cash.
- Fixed assets: purchases of assets do not appear in the profit calculation, except as a depreciation expense split over multiple years. The cash has been spent, but the profit hasn’t been reduced by the same amount.
- Accounts payable or creditors: outstanding bills from a prior period will not appear as expenses in the current period, so they won’t have an effect on the current period’s profit, but they require cash now to pay them.
- Loan balances: only the interest portion of loans reduces your profit, but the whole repayment reduces cash.
- Taxes: prepaid tax instalments do not show up on the profit and loss, and some simple profit and loss statements do not show income tax at all.
- Owner drawings and shareholder/beneficiary loans: depending on how you withdraw funds from your business, that reduction in cash may not appear in the profit calculation.
Timing and Cash Flow Forecasts
Another reason why cash flow is best: timing. Your business needs cash by specific deadlines, e.g. bill due dates, payroll runs, and automatic debits for loan repayments.
To see if cash will arrive on time, use a cash flow forecast.
A cash flow forecast (or ‘cash flow projection’) shows cash coming in and cash going out of the business, for the future weeks or months, broken down into useful categories. At the bottom of each weekly/monthly column is the net cash flow for that period, plus an estimate of the hopefully-positive closing bank balance.
If you need some help with creating a simple cash flow forecast, get in touch.