Revenue VS Profit VS Cashflow
Revenue is the dollar figure that represents how much money a business has earned from selling products or services in a given period of time (i.e. weekly, monthly, quarterly).
It is also broken down further into two categories:
Gross Revenue is determined by multiplying the unit selling price of an item by the total units of those products or services sold.
Net Revenue factors in funds that are subtracted from revenue like discounts, product returns, and other allowances.
The term profit is used to measure the financial success and amount of money a company obtains from revenues (cash in-flow) after paying off all expenses and obligations (cash outflow).
Cashflow is defined as the movement of money in and out of a company and is typically made up of three parts that determine the ability of a business to create/sustain value and growth. Additionally, it refers to the net amount of cash or equivalent that is being transferred – money spent is categorized as an outflow while money received is an inflow.
The three main cash flow classifications are operations, investing, and financing – each contributes to the business’s overall financial health.
Operating
Operating cash flow is defined as money that is directly involved with operating activities – including business and daily operations.
Operating cash flow is important as it indicates the financial health of the business currently and can provide insight on the long-term health of the business that is affected by the amount of funds coming in and the business’s ability to pay operating expenses.
Operating cash flow is calculated by taking all cash received from sales and subtracting operating expenses that were paid either monthly, quarterly, or yearly.
Your sales numbers come from cash in hand, but don’t include accounts receivables – as these funds have yet to be collected.
For example, a catering and events company books 11 weddings in June with recorded revenues of $47,000 – this amount would be a cash inflow.
To measure the strength of this flow they would need to subtract operating costs such as staff pay, equipment, liabilities, rent, vehicle costs and upkeep etc. – these expenses make up the outflow.
If the cash outflow comes to $26,000, this would leave them with a net income of $21,000 for that month.
Investing
An investment cashflow is anything related to long-term assets, including property sales, equipment purchases, and investing in securities.
That being said, if your business purchases a building to operate out of and then later sells the property, any profit is counted as investment revenue.
Company growth can also be funded by investing in things like research and development to expand products and services for additional revenue streams.
Financing
Financing cash flows come from financing activities, including transactions involving equity, issuing debt, and paying dividends. This cash flow can provide insight for a company’s investors by providing an outlook on the financial resilience of the company and its management of capital structure.
Capital Structure is the debt-to-equity ratio companies use to fund growth and operations.
Understanding the importance of having a proper cash flow can help your business avoid experiencing a cash flow crunch.
‘Paying out of pocket’ by using working capital for expensive projects can limit the ability or speed at which a business grows.
Working capital loans are helpful when it comes to contributing to the scale and scope of projects such as a new product launch, plus the research and development that goes into it.
Having a good cash flow means that your business increased liquid assets which enables reinvestment in company growth, while also paying expenses and shareholders.
This also means saving a ‘rainy day’ fund or cash reserve in case of unforeseen financial issues. Having a negative cash flow shows that a business isn’t able to cover operating costs, which impacts the business’s ability to run at full capacity and maintain business relationships with clients and suppliers.
EBITDA
‘EBITDA’ is a formula that is used to track and compare a business’s profitability and performance.
It stands for ‘earnings before interest, taxes, depreciation and amortization’, and is a measure that considers factors that could affect earnings that are not in the business’s control.
EBITDA is calculated by adding the following amounts together:
This figure would be included on the business’s income statement and can be used as a benchmark number against industry averages.
Implications
If a business ends up having a negative cashflow for an extended amount of time, it may force them into insolvency, meaning the business will not be able to continue operating and will have to declare bankruptcy.
To avoid this, businesses can attain proper cash management by implementing a cash budget to understand known costs, while also taking emergencies and unknown costs into consideration.
For example, John owns and operates a tanning salon. Early on he created a cash budget to help him manage and understand the fluctuations in his operating costs.
By creating a cash budget, he can see that his known costs to operate the salon in a typical month come to roughly $12,000 and estimates that his cash inflows for a month, although varying, bring in around $20,000 to $22,000.
After a busy summer, the heating and cooling system in the salon goes down unexpectantly, and John now not only has to pay for the repair but must shut down for a few days while the work is being completed.
Though the situation is an annoyance, because John planned ahead and maintained a healthy cash flow, he is able to cover operating costs, as well as the repair work and loss of revenue without affecting the business’s viability.
The Takeaway
This example nicely highlights the quote discussed at the beginning of this article… when it comes to the small business world - cash really is king.
Working toward a positive cash flow is an ideal, albeit challenging goal in our current economy. However, being on the right track will aid in protecting your small business from the vulnerabilities and uncertainties many industries face. So, if you find yourself in a cash crunch, review your cash flow statement to see where you can make cuts.
Understanding your cash flow is an important part of keeping your business vane and sane, so you can watch that cash reign.
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