The financial health of a business depends on revenue, cash flow and profit. If any of these has problems, the company is affected. A common error is believing that when the cash flow is healthy, profit and revenue don’t matter, but keeping track of all three aspects of a company’s finance is crucial to survive.
Revenue
Revenue is the amount generated in sales during a specific period. If the hiring of tools has generated £150,000 in three months, that is the total revenue for that quarter. Although invoices have been issued for that amount, the cash may not have been received at that time. The revenue earned is the total amount and doesn’t take into account expenditure incurred when producing the items. Although you may have impressive revenues for a specific period, your total profit may be low and, if the invoice isn’t settled on time, the cash flow could be affected.
Cash flow
As the term suggests, cash flow is the movement of income and expenditure for a company. Although you may have a healthy revenue, your cash flow won’t benefit until the invoice has been paid.
Once you have provided a service or goods to a client, you issue an invoice for payment. However, you may not receive payment for 30 days, or even later. In the meantime, you have to pay your suppliers and employees so that you can continue to provide a service. This can cause negative cash flow. If your sales levels are increasing, you may consider buying more tools to meet demand. If you don’t receive prompt payment from clients, you could incur difficulties as your cash flow will be affected.
Profit
This is the amount you have made from each sale. Profit is calculated by working out the total cost of providing a service or producing goods, and then subtracting this figure from the revenue. This leave the profit made.
Problems may occur for a company that is lowering the sale price in order to be competitive with others in the industry. As costs remain the same but the sale price drops, you may win the contract but profit margins will fall.
Balancing profit, revenue and cash flow
To ensure your business is successful, you need to balance all three so that you are aware of how each effects the other in the daily running of the company. You could consider management accounting services, which will leave you free to manage other aspects of the company while finances are carefully managed.
For more advice, please give us a call.