What Is the Difference Between Profits, Revenue, and Cash Flow?
For those who are creating their own small business or startup, there are a lot of financial considerations that need to be reviewed. How much can the business afford to pay its employees? How much backstock should be kept? What kind of workspace best courts success? How much should be spent on marketing and branding?
Perhaps the most important question that small business owners should be asking themselves, however, is related to cash flow.
While it’s important that small business owners are aware of these other questions, it’s far more important that they’re aware of the amount of revenue coming into the company and the amount of cash being spent by the company. If your company is consistently in the red, you won’t remain in business long enough to worry about those other considerations.
It’s important that business owners understand the difference between foundational terms. What is the difference between profit, cash flow, and revenue? How are they different? How do they relate?
What Is Cash Flow?
“Cash flow” refers to the money that moves both in and out of your business each month. It’s one of the strongest indicators of the financial health of your business.
Cash flow includes the income generated by consumers, clients, and subscribers who are purchasing your products and services, as well as the income generated by the collections from your accounts receivable department.
Cash flow also includes the money being spent by your business through payments and expenses. This could be mortgage payments and rent for your business, taxes, fees, and cost of employee salaries, among a variety of other expenses.
In essence, businesses should think of their cash flow in the same way that an individual thinks of a personal checking account. Positive cash flow indicates that more money is coming in than is going out, whereas a negative cash flow means you might find yourself in a bit of trouble covering your bills.
What Is the Definition of Annual Cash Flow?
“Annual cash flow” refers to the amount of cash that circulates in and out of a business during the fiscal year. Businesses can determine their annual cash flow by:
- Gathering all of the cash receipts they receive as payment from customers, money they receive through investors, and outstanding invoices billed throughout the year. This amount equates to your annual cash inflow.
- Add each of the amounts that your business paid as expenses, including employee wages, inventory management and purchases, rent, taxes, and equipment expenses. This number represents your annual cash outflow.
- When you have these two numbers, subtract your total cash outflow from your total cash inflow to determine the annual cash flow of your business. This number can be either positive or negative.
What Is Revenue?
Revenue is your business’s gross income, meaning that it includes all the money a small business takes in as a result of sales of products and services (minus any discounts, refunds, and returned costs that are offered to customers). The terms “gross income” and “revenue” are often used interchangeably.
What Are Profits?
You can determine your profits by subtracting your business expenses from your revenue. These include costs, such as materials to make the products, shipping expenses, and overhead (e.g., employing staff, storing products, and administrative costs). The revenue earned minus those expenditures equate to your profit.
In order to make a profit, however, your revenue must be higher than your expenses. If you find yourself breaking even, or even accruing a loss, you’ll want to increase your profit margin by earning more for your goods and services, or by decreasing your expenses.
Does Positive Cash Flow Mean Profits?
Though the definition of cash flow and profit are similar, it’s easy for profit and positive cash flow to be at odds. In fact, it’s fairly common for companies to make a profit but still have a negative cash flow.
Without the right amount of cash, profits become largely meaningless. All too many otherwise profitable businesses have found themselves bankrupt simply because the amount of cash coming in isn’t enough to cover expenses.
Since cash flow measures the ability of a company to cover its expenses, a company can have a profitable quarter, but still come up short when it comes to covering overhead. If, for example, a business has taken out a loan in order to make ends meet during a previous quarter, their outgoing bills might still keep them in the red, as they’ve previously incurred debt. This is what makes cash flow management so important for businesses’ success.
How Can You Effectively Manage Your Profits and Cash Flow?
There are a number of things that small business owners can do in order to better track their profits and cash flow. Proper management is especially important for startups or newer businesses, as it’s likely that your business will fold within the first few years if you are unable to keep profitability high and cash flow positive.
Know and Understand Your Business Expenses
While it’s important to focus on a business’s profitability, it’s equally important to evaluate your monthly and yearly expenses, such as those incurred by supply chain management, project budgets, and expenses related to keeping your stock up to date and ready to distribute. If these expenses are more than what you bring in through profit, it’s probably time to reevaluate and adjust your strategy.
While there is no universal way to determine whether or not you should try to maximize revenue or profit, it’s important that you look at the two and consider what balance works best for your company.
Reevaluate Discounts You Offer to Customers to Attract Business
While strategic endeavors like discount campaigns can help one to attract customers, small businesses do themselves no favors by offering discounts that don’t allow them to turn a profit. Be sure that, if you do offer discounts, you are not operating at a loss.
If offering discounts will put your business in a difficult position financially, instead, consider alternative strategies, such as bundling services or offering rewards programs for returning customers.
Incentivize Early and Prompt Payment From Repeat Clients
Receiving payments on time improves annual cash flow and also removes the frustration of waiting for money to come in over time. In order to best facilitate this, be sure that your invoices are sent out promptly, especially to clients that you work with month over month. You can even incentivize early payments and repeat customer purchases with discounts. Offering these kinds of discounts will encourage customer loyalty and thus will help to improve your cash flow in a positive manner.
Use Technology to Your Advantage
Ultimately, there are a number of tools that can help you keep track of your cash flow and remain in the positive. It’s important that you take an active role in tracking the money flowing in and out of your organization, have access to data and projections, and determine how fiscally healthy your business is. An inventory management app integrated with your bookkeeping software will also allow you to determine the spend available so you don’t veer into the red.
While there are a number of ways to ensure that your business remains profitable and cash flow positive, cutting costs associated with manufacturing and staff, and raising prices for your products are not always going to be sustainable. By being more cognizant of your finances, technology, and software options, and carefully planning discounts and early-payment incentives, you can help your business thrive.