Get Your Financing Priorities Straight
Running a business can come with more difficulties than one might think, with finances being the most complicated of them all. The main goal for every business owner should be to fully understand the financial aspect of their business in order to become successful. To be able to do that, first you need to understand the main difference between revenue, profits and your cash flow.
Not knowing these terms in detail may ruin your business or lead you straight to bankruptcy if you’re not careful enough. For example, a business can be profitable but still go bankrupt, while another business can survive due to the positive cash flow even though it has no profits. Here are a few tips that should help you get your financing priorities straight.
What is revenue?
Revenue is a total sum of money that a business obtains by conducting business activities over a certain period of time. In other words, it’s an entire income of a business that’s been generated from sources such as sales, interest rates and borrowed capital.
Revenue is classified as operating revenue and non-operating revenue. Operating revenue is money gained from usual activities such as sales, while non-operating revenue is gains that you haven’t planned for. For instance, imagine that, aside from usual sales, your business comes across an opportunity to sell one of its real-estate properties. The initial cost of this property was $5 million, but you manage to sell it for $10 million. In that case, your non-operating revenue is $10 million, while $5 million counts toward profits.
However, business owners tend to make wrong financial decisions based on their revenues alone. Just because your business has high revenue at the moment, it doesn’t mean you actually have that money on you. If you’ve managed to gain $500,000 through invoices, then your revenue is $500,000, but you will get that money when invoices are due in 120 days. That means you’re basically penniless for the next 4 months. So, if you’re planning on restocking inventory next month, you’ll have no money to pay for it and you’ll have to go into debt to cover the expenses.
For businesses that need additional capital for short-term inventory purchases like in the example above, applying for online loans is an option that works for many businesses that experience seasonal revenue fluctuations.
Profit is the sum you get when you subtract your business expenses from your total revenue. In short, it’s revenue minus operating costs. However, there are actually two types of profit you have to take into consideration. The first is your before-tax profit, otherwise known as gross profit. The amount of funds you’re left with after you take your revenue generated from selling goods and services and subtract the costs of those goods and services (COGS). Simply put, the cost required to create and develop your goods and services.
The second one is your after-tax profit, otherwise known as net profit. This is the amount you’re left with after you take revenue from selling goods and subtract the COGS expenses and additionally subtract other business expenses, such as payrolls, utility bills, maintenance bills and taxes. Now your net profit is the amount your business has actually earned during a certain period of time. You can use that amount to procure inventory, expand your business and hire additional employees.
Cash is king in the finance world the same way content is king in the marketing world. What exactly is cash flow? It’s the timing and the amount of money you receive on your bank account as well as the expenses you have to pay. On that note, if you earn more cash than you spend, you have a positive cash flow, while if you spend more cash than you earn, you have a negative cash flow. Negative cash flow is what kills businesses. The key to running a financially stable business is in identifying when your cash income is due and when your expenses are due. If you get the cash before you have to pay the expenses, then you’ll be fine. On the other hand, if your expenses are due before you get the cash income, you’re in trouble.
Here’s an example: Let’s assume you’re getting payments from collectibles, such as invoices. You secured invoice payment of $50,000 that’s due in 60 days and another invoice payment for another $50,000 that’s due in 90 days. Now here’s the kicker – you’ll have the first payment available in 60 days and another in 90 days generating total revenue of $100,000, but you have to pay your employees their salaries the next month. Now you’re in a cash crunch, because your expenses are due before your cash income. However, invoice finance can instantly improve your cash flow, because you’ll be able to collect payments before the invoice is due and pay off your employees. But, if you’re unable to secure that payment, you’ll have to find other means to pay off your employees.
Achieving financial success for your business and yourself consists of understanding revenue, profits and cash flow while prioritizing them accordingly. If you focus on a single aspect only, you’ll be at risk of losing your business. That’s why you need to keep all three aspects in line. Make sure you maintain a positive cash flow, increase your revenue and secure profits to ensure your business success.