As a business owner, you understand the importance of tracking cash flow into and out of your business. You sell products and services to increase cash flow coming in, you monitor cash flow going out. If cash coming in is more than cash going out, you turn a profit; investors are happy, and your financial situation looks great. But is cash flow a revenue or expense?

Understanding cash flow is critical to the success of your business. Along with revenue, they measure your financial condition, including whether you will be able to meet your financial obligations or experience growth.

Let’s take a deep dive into the difference between cash flow and revenue and how to use the income statement and statement of cash flows to understand your business needs further.

What’s the Difference Between Cash Flow and Revenue?

Revenue is money generated through sales of products and services. Cash flow is cash generated through operations, investing, and financial activities. Revenue is included in cash inflows when it is paid.

There are two methods of accounting: accrual and cash basis. Revenue is reported on an accrual basis or when it is earned. Cash flow is reported on a cash basis, meaning when it is received or paid out.

Revenue is reported on the income statement, and cash flow is reported on the statement of cash flows. If you lack positive cash flow, you cannot operate your business. If you lack positive revenue, your company is unhealthy, and you must determine ways to generate more sales to be sustainable.

Revenue VS Profit VS Cash Flow

Before understanding the relationship between revenue and cash flow and how each affects profit, let’s examine these three concepts individually.

Revenue

Revenue is income earned from the sale of goods and services, plus interest, fees, and royalties. The key word here is “earned.” Revenue is not necessarily in your bank account yet and available to spend, but it is promised. For example, you perform a service for a customer and send them an invoice. This money is counted as revenue even though the customer has not yet paid for the service. 

Revenue is calculated on the income statement for a specific period of time. This is also referred to as the accrual method of accounting. 

Revenue must be greater than expenses if the company is to remain in business. A net loss means insufficient funds to pay bills, now or in the future.

Profit

Profit is revenue minus expenses. For example, if you bill a customer $10,000 for a service and it costs you $5,000 to perform that service, your profit would be $5,000. There are two types of profit: gross and net.

Gross Profit

Gross profit is revenue from the sale of goods and services minus what it costs to make those goods (cost of goods sold). These are costs directly associated with the task, such as materials, labor, etc. 

Net Profit

Net profit is revenue minus expenses but includes all business expenses, not just those directly related to producing a particular good or service. You would include costs associated with keeping the business running, such as payroll, utilities, and taxes.

Cash Flow

Cash flow is money coming in and going out of a business. Unlike revenue, cash flow is recorded when it is received. This is cash on hand and is available to spend on expenses. 

So the big difference between revenue and cash flow is when the money is available for use. If you bill a customer $5,000 and they pay in two installments. Revenue incurred is $5,000, and cash flow is $2,500. Once they pay the second installment, cash flow adds another $2,500, but there is no more revenue.

Sufficient cash flow is required to run a business. The difference between cash flow and revenue is what you are owed and will receive in the future. Revenue can be used to forecast cash flow (assuming the customer pays on time and in full).

Understanding Income, Expense, and Cash Flow Statements

Now that you clearly understand income, profit, and cash flow, we’ll move on to the two financial statements that calculate these numbers and how you can use them to determine whether your business will flourish.

Income and Expense Statement

The income statement (also called the profit and loss statement) is a summary of revenue and expenses for a specific period of time. Often companies will prepare an income statement on an annual basis, but its usefulness lies in providing a snapshot of financial health at any time.

An income statement is a compilation of revenues, expenses, gains, and losses.

1. Add all of your revenue for the time period—including sales
2. Subtract your expenses for the same period—including wages, rent, utilities, interest, supplies, inventory, and any other expenses from your business
3. Add in any gains made from the sale of assets
4. Subtract any losses from settlements or investments

The result is your net income or loss.

Income statements serve several purposes:

1. Provide details of whether a company is profitable and what business activities contributed to its financial situation. This is beneficial for shareholders and investors.
2. The income statement also provides management with details about whether they have the means to expand the business or whether they should cut costs.
3. Comparing income statements over several periods points out company business structure trends. If the company consistently shows a profit, it is on the right track and a good investment opportunity. If the company exhibits a loss, more investigation needs to be made into the cause of the loss. Is the company not producing enough revenue to keep up with expenses? Was there a sell-off of equipment or property? Was there a one-time settlement, or are the losses longer-term?

Income statements can also be used to compare companies in the same industry to see if the profit or loss is contained to the company or if it is an industrywide trend.

Statement of Cash Flows

The statement of cash flows looks at cash from three different areas: operating, investing, and financing.

1. Operating cash flow is cash from a company’s main business activities. The report begins with net income derived from the income statement. Then adjustments are made for cash, cash equivalents, and non-cash items. Accounts receivables, depreciation.
2. Investing cash flow is cash from purchasing or selling long-term assets, such as equipment, plant, property, and investment securities.
3. Financing cash flow is cash from the sale of stocks and bonds, or money borrowed from banks or investors.

A positive cash flow means that you are able to pay your invoices. Excess cash flow enables you to make decisions on growth—buy more equipment or inventory or hire more personnel. A negative cash flow means that you must either generate more income or cut expenses. You could also take out a loan or liquidate a surplus asset.

Use Statements Together

Financial statements show a company’s performance during a specific period of time. They are required if you have shareholders or investors and provide information about revenue, expenses, profitability, and whether it can fulfill its obligations.

The income statement provides the net income dollar amount required to complete the cash flow statement. Once the two financial statements are complete, ratios that are a goldmine of information regarding profitability and liquidity can be calculated.

Profit Margins measure a company’s profitability. There are several types.

• Gross margin is revenue minus the cost of goods sold
• Operating margin is revenue minus the cost of goods sold and operating expenses
• Pretax margin is operating margin minus other non-operating expenses
• Net profit margin is the bottom-line revenue minus all expenses and taxes

Each of these margins indicates the company’s ability to generate earnings. Figuring out ratios at each step allows a company to pinpoint where to focus any adjustments. For example, if your gross margin is low, examine revenue sources and what goes into producing that revenue. If that ratio measures up against the industry standard, add the operating expenses and see what the ratio looks like. If it’s low, look closely at operating expenses and where you can make adjustments. 

While companies may not be able to survive without cash flow, the barometer of a company’s health is in the income statement. Cash flow can be inflated, but the bottom line number that investors look at is profit.

People often assume a correlation between cash flow, revenue, and profitability. In reality, a company can generate a lot of revenue that will eventually turn into cash flow, but not immediately. If a company has a lot of revenue, but little cash on hand, it might be unable to cover expenses to keep moving forward.

An Example of the Difference Between Cash Flow and Revenue

To illustrate what we’ve discussed here, let’s dive deeper into revenues, expenses, and profit and see how they affect both the income and cash flow statements.

Revenue Generated

If you are in business to make money, you need to generate revenue. Revenue allows you to cover your expenses, realize a profit, and continue doing business.

In its simplest terms, revenue is money from providing goods and services. But if it’s lagging for one reason or another, you will need to find ways to increase sales.

1. Refine your offer by researching what your customers want and finding new ways to provide it.
2. Marketing strategies can generate new interest in your product, and new markets can open doors to more sales.
3. Analyze your pricing strategy. What differentiates you from your competition, and can you exploit that to your customers to justify a higher price?
4. Focus on your best customers and upsell other products or services from your current offering.
5. Ensure your customers are paying invoices on time or sooner. Revenue needs to convert into cash at some point, and the faster that happens, the better your cash flow will be.

Expense Incurred

The other half of the equation is controlling expenses. If expenses are high, it puts pressure on revenue generation. If expenses are high, it also puts a dent in cash flow. Determining ways to cut costs helps both cash flow and profits.

1. Examine physical expenses related to producing and selling your product or service, such as inventory and labor. Negotiate with suppliers—the better margins on a per unit basis, the more profit per sale.
2. Evaluate expenses related to running your business but not directly related to the production process. Look at insurance rates, rent for office space, utilities, office supplies, personnel expenses, and any other expense that occurs during the course of doing business.
3. Look at your processes. Time is money, and if you can cut time spent on unnecessary processes, it will affect your profit.

Profit Recognized

Increasing revenue and decreasing expenses are the key to recognizing profit. On the other hand, cash flow can be increased through outside means, such as an influx of cash from owners or creditors. 

Both revenue and cash flow support a business’ profit stream. Revenue affects the income statement directly as it’s a factor in its calculation. Net income is the initial entry on the cash flow statement.

A continuous revenue stream is essential for a positive cash flow. Without cash flow, a business suffers. The point is that revenue and cash flow are intertwined. But while a company can profit by increasing revenue, a company cannot function without adequate cash flow. Studying both carefully and taking steps to increase revenue and reduce expenses will increase profits and result in a positive cash flow. 

The Final Say

While companies should focus on revenue and cash flow separately, understanding how they affect one another is essential. Sales revenue, profit margins, and a positive cash flow are equally critical for a healthy business. 

Running a business is complicated, and you need all the tools you can get to succeed. Financial statements are one of the best resources for decision-making. For more resources, check out our extensive library of articles to create and keep more of your wealth.