What’s the connection between revenue and profit?

Today, there are nearly 30 million small businesses in the United States. And while big corporations may have the most name recognition, small businesses with fewer than 500 employees account for 99.7% of all businesses in the country! Together, all the micro-companies, garage-based businesses, local franchises, and regionally recognized brands employ an incredible 56.8 million people. 

It’s clear that small businesses have a big impact on the communities and people they serve, if they can stay in business. 

Unfortunately, according to data from the Bureau of Labor Statistics , as many as half of all small businesses fail within their first five years of operation. And the biggest contributing factor? Poor cash flow.

According to an often-cited study by a U.S. Bank, a full 82% of small business failures are caused by poor cash flow or a lack of understanding of how cash flow impacts operations. These businesses may have started out successful, but within a few months or years, they struggled to purchase inventory, expand their workforce, streamline operations and build their brand. 

When it comes to running a successful small business, healthy revenue isn’t enough.

When your small business begins bringing in revenue, it’s easy to assume you’re on the path to success. But there’s a distinct difference between a business’s revenue and its bottom-line profit. And that’s what gets small business owners into a financial bind.

Revenue refers to the total amount of cash you generate by selling your products and services. This number is typically near the top of your income statement. In a healthy, debt-free business, this number should be the largest on your financial statement.

Profit, on the other hand, refers to the amount of cash left over after you’ve covered your business’ expenses and liabilities. The cost of inventory, shipping costs, and even rent, labor and utilities all impact this bottom line number. 

If you put too great of a focus on your top-line revenue, and don’t carefully watch your bottom-line profits, you can experience crippling cash flow issues, growing debt, and difficulty covering your daily expenses. 

Cash flow issues don’t just impact your ability to cover rent. They can prevent your business from growing. Expansion often requires investment, like buying a new building or pre-purchasing a large quantity of inventory. But if your business is facing major cash flow problems, you may struggle to save the cash needed for these investments. And in today’s tight lending environment, banks are becoming increasingly hesitant to lend capital to businesses that don’t have visible profits. 

How can you build revenue and profitability?

There are a few strategies you can leverage to increase your small business’ revenue and profits, or to reduce expenses and grow your profit. 

Track every number. As your small business grows, so will your expenses. Unfortunately, for many small businesses, their expenses grow faster than revenue. That puts these businesses in a losing position. To strengthen your cash flow, track every new and growing expense that impacts your bottom line. Before you add a new software, hire a new team member, or rent a larger office space, project your expected revenue for the next 12 months to determine if that decision could cost your business more than it may generate. 

Analyze your costs carefully. By putting a cash management system in place, you can project your income and expenses over the next 30 to 90 days. If you notice that your income will drop below your expected expenses at any point, consider ways to reduce that cost — or delay the payment. 

Always have a backup plan — and savings! Even with a cash management system in place and a careful cash flow plan set up, unexpected expenses and income disruptions happen. That’s why future-focused small businesses always have a backup plan, and an emergency cash fund, ready. By having a bit of cash in reserve, you can protect your small business from going into debt or making a late payment, protecting your bottom line and your creditworthiness.

Every small business needs a financial strategy — and a knowledgeable partner.

As a small business owner or entrepreneur, you have a lot on your plate. You’re likely leading product development, hiring team members, running your marketing department, financial planning, meeting with customers, courting investors and more, all in the same week! 

Instead of managing your own business finances, consider outsourcing your essential financial tasks, like reporting, planning, analysis and forecasting. By engaging an outside professional, you free up your own team to focus on the internal tasks they’re best at and give the financial side of your business the dedicated attention it needs. 

You’re an expert at what you do. But that doesn’t mean you need to be a financial expert also. When you partner with a true finance professional, you gain instant access to the kind of advanced knowledge that would take you years to learn on your own. And by harnessing the power of this tailored expertise, you have the opportunity to not just survive your business’ first five years, but to grow exponentially through them. 

Want more? Escalon has helped over 5,000 companies across a range of industries to optimize routine business functions, like taxes, accounting and HR. Talk to an expert today.

This material has been prepared for informational purposes only. Escalon and its affiliates are not providing tax, legal or accounting advice in this article. If you would like to engage with Escalon, please contact us here.