How much money did your company make last year?
If there was ever a complicated question disguised as a simple one, that’s it. For small business owners, it’s not just a matter of making small talk — it’s the foundation on which you’re building a business.
Understanding the distinction between your revenue, profit, and cash flow can help you make better plans, understand your tax liabilities, and have better luck courting investors for your business.
Revenue — the top of the charts
Revenue is the headliner of almost any organization. While publicly traded companies often get knocks or praise for their profit per share, most small businesses think in terms of revenue growth. Revenue is everything that your company earns. If you sell 300 widgets at $10 apiece, then your revenue is $3,000. It’s that straightforward.
Revenue is a great measure of the overall demand that your business is generating. As your revenue goes up, you know that you’re selling more stuff or services.
The downside of revenue is that it doesn’t capture information about how efficiently your business is running. Sure, you made 10% more this year than last but how much did you spend on that Super Bowl ad? If it costs you more than the revenue you get back at the end, you’re not really moving your business forward.
When it comes to investors, there’s a divide. In the tech start-up world, revenue is often seen as the end all, be all of finance. Venture capitalists look for companies that can ramp up revenue regardless of cost, hoping to figure that bit out later on down the line.
In the world of more classic, Warren Buffett style investing, revenue is almost meaningless. These investors — which may also include your business banker — want to see money making it all the way to the bottom of the earnings statement.
In short, revenue is a useful, but very broad, indicator of how well your business is doing.
Profit — all the cash that’s fit to spend
At the very bottom of the income statement is the profit line — sometimes called “net income.” Profit is the money that’s left over after everything — cost of goods, salaries, taxes, rent, the dog food for your office schnauzer, etc. — has been paid.
Profit is what business owners get to play with when all is said and done. Usually, this money ends up being saved for future investments or given back to people who own a stake in the business.
As a conversation topic, profit is a difficult one to just drop in. Not only does it vary wildly by industry, it also takes into account a lot of variables that are in constant flux. Your profit may fall or rise based on taxes, for instance, but that might not reflect anything about your business, just about the tax environment you’re operating in.
Profit is the thing banks want to see, because having a good profit means not only getting new business, but getting it in a responsible way. There are very few companies that don’t ultimately get judged on their profit.
Cash flow — keeping the doors open
Cash flow is one of the most important concepts that business owners fail to understand. If your company makes $4 million a year and it only costs $3.5 million to keep the company running, you should be in a good place. But if that $4 million all comes in December, it’s going to be a rough 11 months.
Cash flow can be measured on anything from a daily to an annual basis, and it’s the measure of how much actual money you’re pulling through the door. Revenue can sometimes be affected by things like recurring subscription fees, which may be recognized on the balance sheet when they’re charged, not when they’re paid.
Your cash flow is, in many ways, the most honest view of your company possible. Investors often use a slightly modified version called “free cash flow” to determine the strength of businesses. After all, cash is king, and no matter how popular you are, you can’t open the doors without paying for them first.
Again, you’re unlikely to bring up cash flow in a cocktail conversation. Cash flow is so detailed and specific, that it’s unlikely to give anyone a good idea of how your business is doing, unless they also understand all the costs associated with running the place.
The bottom line
None of these measures is a magic bullet for your company, but not knowing them can cost you. By focusing your actions on each distinct measure — revenue, profit, and cash flow — you can make sure that your business is putting its best foot forward at all times. Investors and bankers are keen to see that you understand the nuts and bolts of your company, and understanding the distinction between these terms is a step in the right direction.
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