You may have heard the expression: ‘Revenue is vanity, profit is sanity and cash is reality’. If ever there was a philosophy which I passionately believe in, it is this.
However, there are three important financial measures, which we need to unpack in this expression. Let’s look at each of them in turn;
1. Revenue growth
Revenue is often referred to as the top line in a Profit and Loss statement (P&L). However, it can be something of a vanity number and many businesses can place too much emphasis on it.
It’s pointless having high revenue if at the end of the year it equates to zero profit. This is not a formula for success in building a high performing, sustainable, legacy organization.
However, profit point aside, revenue growth is critical because, once your fixed costs and overheads are covered with a carefully managed and controlled direct cost of sale, scale and growth in your top line will massively fast track your growth and success.
What revenue is and what it isn’t
Revenue is the total amount of money that you have earned, coming into your business over a defined period of time. For most businesses this is a monthly accounting cycle rolling up into a yearly financial period.
It is not the total amount of cash coming into your business. Cash can come into your business for a variety of reasons: financing, advance payments for services to be rendered in the future, payments of invoices sent months ago.
2. Profit generation
When we speak about profit, it’s common for there to be some confusion about exactly what it means. To be as simplistic as possible, profit is the amount that is left over after each sale, once you’ve deducted all your costs, which I have no doubt you already understand.
A company’s total revenue (equivalent to total sales) minus the cost of goods sold (COGS). Gross profit is the profit a company makes after deducting the costs associated with making and selling its products, or the costs associated with providing its services.
As a simple example, if a company sells goods for $100, and the cost to the company to produce the goods is $70, the company’s gross profit is $30, equating to a gross profit margin of 30%.
The second key profit indicator, net profit, is a more accurate measure of a company’s profitability because it takes into account not just the direct costs of sale and production but all the fixed and variable costs of running the business.
Net profitability is an important distinction, since increases in revenue do not necessarily translate into actual increased profitability.
Net profit is the gross profit (revenue minus cost of goods) minus operating expenses and all other expenses, such as taxes and interest paid on debt.
Managing the double lines (driving top line revenue growth and, in parallel, focusing on the overhead and cost base), will allow you to deliver accelerated, sustainable, and profitable business growth.
However, managing the double lines in your growth model can easily be derailed if you don’t have one eye on your cash management strategy and if not carefully managed it can be the Achilles heel of your growth ambitions.
3. Cash management
More businesses go bust coming out of a recession than they do going into one. Why? Because they overtrade and stretch themselves beyond their financial reserves, which have already been substantially diminished during the recession itself.
Managing cash is critical and this is the third of our ‘Measures that Matter’. Your cash management strategy in terms of your daily/weekly/monthly/yearly trading is fundamentally about one measure that really matters: your debtor to creditor ratio.
It still amazes me today how many senior business leaders, business owners, and entrepreneurs don’t instantly know what their debtor and creditor numbers are running at, whether for the year to date or as a trend.
The simple fact is that nearly every business is both a creditor and a debtor, since businesses extend credit to their customers, and pay their suppliers on ‘delayed’ payment terms.
Cash can be what stifles the growth potential in businesses and proactively managing the ratio between these two levers is key to being able to fund your growth ambitions for your business.
Your debtor management . . . you’re not a bank
When I work with clients and we start drilling into their financials, cash management and, even more specifically, debtor to creditor management come up as a key discussion area, without fail.
I’m normally drawn into a focused conversation where I end up making the following statement: ‘I didn’t realize that a secondary part of your business proposition was providing financing for your customers.’
I’m sure you know where I’m headed with this point. You are not there to provide a free credit facility for your customers, yet too many businesses indirectly fall into this trap.
Don’t let your debtors treat you like one. It will cripple your growth potential and will lead to sleepless nights for many business leaders, business owners, and entrepreneurs, because they can’t pay their employees and bills.
The second lever, creditors, is all about your effectiveness in negotiating payment terms with suppliers and partners to ensure you’re maximizing your debtor to creditor ratio.
Of course there are other creative ways in which you can unlock the cash in your business, but this goes back to the gross profit margin you’re making, as there is always a cost involved in such solutions.
As a business owner, there are some key financial tools you must get used to reading. Not just get used to reading but also develop the skill and ability to interpret the insights from the numerical data they provide, in order to make informed, well educated, empirically validated decisions, to drive your business forward. They are;
- The Profit and Loss (P&L) statement; a report of the changes in the income and expense accounts over a certain period of time (monthly and yearly being the most common). My preference is for a trended P&L, which shows the trends in revenues and expenses over a period of time, for example three to five years. This will allow you to see the high level year-on-year trends with revenues increasing (hopefully) and tight management of the cost base (hopefully less than revenues). Remember the key in business is always ‘no surprises’.
- The balance sheet which records the balances of all asset and liability accounts at any given point in time.
- The cash flow statement; a report of the changes in all of the accounts (income/expense and asset/liability) in order to determine how much cash the business is producing or consuming over a certain period of time (monthly and yearly being the most common).
Don’t try to navigate your business blind. Use these financial tools constantly as part of your daily routine, and stay on top of your numbers.
About the author
This guide has been written exclusively for ByteStart by Royston Guest, author of Built to Grow, a proven time-tested formula full of practical strategies, tools and ideas into what it takes to build a truly high performing business. Download your free Built to Grow chapter ‘The Fundamentals of Business Growth‘.
Last updated - 4th April, 2017