Revenue is the top line earnings of your business, also often referred to as sales.
Cash flow is what you actually receive in payments from your customers less what you actually pay for expenses and capital purchases.
Accrual Accounting Method
Accrual basis accounting is the most accurate generally accepted form of accounting (vs cash basis), as its objective is to match earned revenues and incurred expenses for an accounting period. This is designed to give a more accurate picture of profitability for any given period.
What is accrual accounting really doing?
In accrual accounting, when a triggering business activity occurs, a revenue or expense is recorded.
For example, if you provide a product or service to a customer, you have earned revenue. Accrual accounting says you should record the revenue in that accounting period because that is when it was earned.
The same goes for expenses. If someone provides you with a product or service, you have an expense to record. This is proper accrual accounting.
In both examples (revenue and expense), you ideally have an invoice that you can use to record your revenue (seller) or expense (buyer).
However, if there is a delay in invoicing, accrual accounting tells you to record the revenue or expense anyway. In some cases you may need to record an estimate, with a true up in a subsequent period when the actual amount is known.
Accrual accounting example
For example, let’s say your accounting period is monthly. You know that your law firm provides professional services during the month. However, they typically invoice you a few weeks after the end of the month. As a small business, you likely need to close your books faster than that. As a result, you won’t have an invoice from the law firm by the time you close the books.
Accrual accounting still requires you to record that expense, as services were provided. You would then estimate the expense and accrue it for the month the work was performed. In the following accounting period, when the actual invoice is received, a true up adjustment would occur to adjust the accrual estimate from the prior month to the actual amount. In other words, rather than record zero in month one, you would record your best estimate which will be much closer to reality, resulting in a more accurate income statement for that period.
Cash Flow
Cash flow represents the true movement of cash to and from a business.
When you record revenue after providing a product or service to a customer, an accounts receivable is also recorded. In other words, you recorded revenue because you earned it, but you have not yet been paid for it. Cash flow occurs when your customer actually pays the accounts receivable. This could be the same day, or it could be months later.
In other words, you earn revenue today by providing a product or service, but you might not receive the cash for a number of months. Without cash you don’t have the money to pay your bills. You can see how understanding the timing and expected receipt of cash becomes so important for cash flow management.
Example: Revenue and Expense vs Cash Flow
| Example | Accrued Revenue or Expense | Cash Flow |
|---|---|---|
| Product or Service of $10,000 is Provided to the Customer | $10,000 of revenue is recorded | $0 cash flow |
| Customer pays the $10,000 invoice a month later | $0 is recorded (already recorded when the product or service was provided) | $10,000 of cash inflows occurs as the receivable is paid |
| Legal Services are provided to the company. No invoice yet at the end of the month. Services estimated to be $5,000 | An expense of $5,000 is accrued as an estimate to close the accounting period. | $0 in cash outflows. Nothing has been paid yet |
| Legal services invoice of $5,800 is received in the following month. | In the following month, the $5,000 accrual is reversed and the actual invoice of $5,800 of expense is recorded, for a net impact of $800 in month 2 ($5,000 recorded in month 1 and $800 recorded in month 2) | $5,800 of cash outflows occurs when the invoice is paid. |
Revenue and Expenses vs Cash Flow example explained
So, as you can see in the above example, revenues of $10,000 and expenses of $5,000 were recorded in month one, but the cash flow was zero.
In month two the cash inflow was $10,000 (customer paid the invoice) and the cash outflow was $5,800 (legal invoice was paid).
Month one had net cash flows = zero. Month two had net cash flows = $4,200 ($10,000 inflow – $5,800 outflow).
Cash flow can become a problem if, in this example, the customer fails to pay in month two. Unless you have enough cash in the bank or a line of credit to use, you would be unable to pay the legal invoice due to a lack of cash flow.
This obviously becomes much more complex and dynamic as you have hundreds or even thousands of transactions occurring each accounting period. You can see how cash flow management becomes critical to the survival of the business.
Revenue terminology
Revenue = Sales. Those terms are often used interchangeably. Revenue can be due to sales of products or services.
Revenue is shown at the top of the income statement, which is often why it is referred to as “top line” earnings.
Revenue can broken down further into Gross Revenue and Net Revenue.
For example, Gross revenue is the very, very top line. In the example above it was $10,000. If the customer later returns $500 of products, or you give the customer a $300 sales rebate, the net revenue becomes different than the gross revenue. This would bring the net revenue (or net sales) down to $9,200.
| Income Statement category | Amount (USD) |
|---|---|
| Gross Revenue | $10,000 |
| Returns & Allowances | ($500) |
| Rebates | ($300) |
| Net Revenue | $9,200 |
Financial Statements
The three main components of a company’s financial statements include a (1) Balance Sheet, (2) Income Statement and (3) Statement of Cash Flows. They are all important to understanding the financial health of a business and in making important business decisions.
The balance sheet is a snapshot in time, showing the assets, liabilities and equity of a company.
The income statement shows the profit or loss of a business, which is why it is often referred to as the “P&L” (Profit and Loss) statement. This will be for a specific period of time, typically a month, quarter or annual basis.
The income statement will have the company’s revenue on the “top line,” and then it will show expenses and other income to arrive at a net income or net loss for the period. The net income or loss is also referred to as the “bottom line.”
The Cash Flow Statement will show the roll-forward of the cash balance from the beginning to the end of the period. It primarily uses the change in balance sheet categories along with certain income statement components to calculate the cash flows from Operating, Investing, and Financing activities.
Cash Flow Statement
The cash flow statement is very telling to how the business is really performing. A company that regularly has a negative cash flow from business operations is not a good trend.
Remember that financial statements look backward to the past. This is critical information to understand how the business has performed. Even more importantly is to understand why the results are what they are.
Cash flow from Operating activities will show you how much cash your business generated or lost from operations, which is the core business. This excludes cash from investing or financing activities, which are shown separately.
The categories within each cash flow section will help you understand where the cash went.
For example, if your cash from operations is down and you can see that lots of dollars went into accounts receivable and inventory, it means that your future cash inflows are tied up in those assets, and you need to collect on the accounts receivable and sell the inventory in order to subsequently realize that cash flow.
| Cash Flow Statement Category | Cash inflows / (outflows) |
|---|---|
| Net income | $5,000 |
| Addback: Depreciation | $1,000 |
| Increase in accounts receivable | ($10,000) |
| Increase in inventory | ($2,000) |
| Increase in accounts payable | $8,000 |
| CASH FLOW FROM OPERATIONS | $2,000 |
| Additions of fixed assets | ($9,000) |
| CASH FLOW FROM INVESTING ACTIVITIES | ($9,000) |
| Borrowing from line of credit | $20,000 |
| Dividends paid to shareholders | ($5,000) |
| CASH FLOW FROM FINANCING ACTIVITIES | $15,000 |
| Increase / (decrease) in Cash & Equivalents | $8,000 |
| Cash & Equivalents – beginning of period | $2,000 |
| Cash & Equivalents – end of period | $10,000 |
Cash Flow Projection
Many small business owners are well served by performing cash flow projections on a regular basis. With these projections you plan your cash flow in the short term (days and weeks) and also the long term (months).
These types of cash flows are quite granular, as you are literally planning on what is your incoming cash flow is going to be each day as well as your outgoing cash flow, such as your expected accounts payable and payroll payments.
Businesses with very strong positive cash flow can often back off on doing detailed cash flow projections, especially if the company also has a line of credit with a bank to draw on when needed. Many businesses, however, don’t have a reliable inflow of cash, and often have to make decisions on what accounts payable invoices to pay or not pay, in order to make payroll that week.
Planning your daily cash inflows and outflows, and updating them to actuals on a day-to-day basis will allow you to learn and get better with estimating. The key is to identify potential cash flow constraints early enough so you can make adjustments such as building a cash reserve, before you hit a cash crunch.
For example, you will avoid committing to purchase a large capital expenditure in times where cash will be tighter. Instead you can plan to save for these types of cash outflows over time or arrange financing well in advance with payments that fit within your cash flow projection model. This will help avoid an emergency scenario of a large unmanageable cash outflow hitting at the wrong time.
Negotiating a line of credit with a financial institution will help quite a bit as it will provide a buffer to help avoid cash flow problems.
Executive Summary: Understanding the difference of revenue vs cash flow
- Revenue is the top line of the income statement, but won’t become cash until it is collected, which is the key difference (timing and collectability)
- Net cash flow is the collection of accounts receivable and other sources less the payment of expenses and other business investments
- Accrual basis accounting records the revenue when it is earned, not when paid, which would be the cash inflow portion
- Expenses are recorded when incurred in accrual basis accounting, not when paid
- The payment of the expenses would be the cash outflow
- Gross revenue is the top line, and is often reduced by customer rebates and returns to arrive at net revenue (or net sales)
- The standard financial statements of a business are the balance sheet, income statement, and statement of cash flows
- The income statement contains the revenue, total expenses and profit from an accrual basis over a set period of time
- The balance sheet is a snapshot of your business health as of a point in time. Essentially it is a life to date snapshot of your business at that point.
- The Cash Flow statement shows the cash flow of the business over a specific time period, with the very important cash flow from Operations category
- The Investing and Financing sections of the cash flow statement are also telling on where the cash went or came from over that period
- Projecting cash flows can be very helpful to businesses to avoid a cash crunch situation
