Understanding financial terms and what they show is helpful for small business owners, investors, and anyone else who needs to assess business performance. Amongst the various terms used, gross revenue and free cash flow are critical to a business's performance and are usually at the fingertips of management and other direct stakeholders.
Knowing what cash flow and revenue mean, we can use them to get a quick overview of a business's operations and performance. We will help you understand cash flow and revenue and explore the part both play in the financial effectiveness of a business.
Cash flow and gross revenue for a business are two useful financial metrics for measuring its financial condition. Cash flow indicates the business's liquidity and shows how much cash is coming in and out. Gross revenue shows how much the firm is selling. However, it is an accounting transaction.
What is gross revenue?
Gross revenue is what a business earns from the sales of its essential goods or services as well as other sources of income. This means that the earnings of a newspaper printer will be revenue from newspaper sales and advertisements. Additional income of a newspaper is from ads, but that is secondary. If a newspaper doesn't sell well, it won't get many advertisements, would it? This is an oversimplification for explanation purposes, however.
Gross revenue is also the top line since it is always shown at the top of an income statement. Also known as a profit and loss statement, this is a summary of a business's earnings and costs made to earn that income. Gross revenue is earnings, including operating profits and expenses. Net accrued revenue or net profit, or net income are all terms for the net gains after deducting business expenses from the Gross Revenue.
Revenue reporting methods can vary according to the business's industry and the accounting methods used. For example, in the fashion industry, many companies report their revenue after netting off returns, which can be high. Many therefore report net sales instead of gross revenue.
Larger businesses also report revenue from their different lines of business under a consolidated income statement. Others prefer to list gross revenue from their main line of business, while others are reported under a clubbed-up figure. All of these methods are okay to use under accounting practices.
Understanding gross revenue
Gross revenue can include other income sources like franchising fees and royalties earned, which is always for a period specified in the income statement. Gross profit could be monthly, quarterly, or annual. When businesses offer credit, the gross revenue may show a different value. The actual cash position will be different in the balance sheet or cash flow statement, as the company has not been paid yet but has delivered goods to its customers.
A business may report gross revenue consisting of invoices sent, account receivables, and cash. All these are considered part of gross revenue as the company has sold and earned money in accounting terms.
In short, the term gross profit indicates the earnings of a business. It is all-inclusive and covers sales and income from secondary sources, apart from what the company is supposed to do. This makes it different from sales, which are specific to the primary business.
Gross Revenue is usually reported with separate line items like operating income, income from secondary sources, and non-operating income, listed under the top line to show details of how the earnings can be broken down into smaller sources. The bottom line shows a net profit.
What is cash flow?
Just like the income statement shows gross revenue and all other sources of earnings, the cash flow statement shows the sales generated by all normal business operations. There are different sections of the cash flow statement, one of which is the cash flow from operations or operating cash flow, which uses the company's net income figures (taken from the profit and loss statement).
Since a business has other activities apart from its operations, like borrowing, equity management, etc., the financing cash flow section will show money, or cash received and paid to banks, bonds, shareholders, and private equity holders. This is all cash or receivable payable that the business needs to pay to its lenders or other stakeholders.
Similarly, the section on investing cash flows gives details of investing activities. This usually includes any capital expenditure, business acquisitions, sales of old machinery, and other items. The net cash flow refers to the balance of cash and its equivalents that the business has left over after all cash inflows and outflows for the period are complete.
If the cash flow is positive, it means that the business is cash positive or it can manage its loan payments and operating expenses and meet other expenses. Since cash flow does not need accrual, it reflects the business's actual financial (cash) position. This is significant because it helps the company and other people interested know how well it is earning. A business may report good gross and net revenue figures but have negative cash flows.
The difference between cash flow and gross revenue
Cash flow differs from gross revenue in several ways. Gross revenue is just a reflection of how well the company has sold its products or services. This means that the figure includes unreceived payments (credit sales), and revenue is there, but the business has a poor cash flow because it's all credit payments.
Secondly, the gross revenue doesn't tell us how much profit the company generates from these sales. On the other hand, cash flow shows how much money flows into and out of business. A negative cash flow indicates that the company has no money generated. For decision-makers, alternate revenue streams can be identified if the business is earning money from an alternate source that can be converted into a second line of business.
For example, consider the following business. Company Sue's Things makes stand mixers and distributes them through kitchenware stores and supermarkets. Sue's Things made a stand mixer worth $200 to their client The Yawing Walrus and booked the sale under its sales account.
However, since Sue's Things offers its stores a 15-day credit (usually known as n-15 terms), The Yawing Walrus doesn't pay cash immediately. Sue's Things sends the invoice for the mixer to The Yawing Walrus and records accounts receivable of $200 against The Yawing Walrus's ledger. Now note that in this situation, there is no cash involved. This means that while revenue will be booked, the cash flows will not be affected by this transaction.
What is a good cash flow to revenue ratio?
Financial ratios show the linkages amongst earnings, net income and cost of goods sold, and other heads that a specific ratio measures. People interested in a business can use different ratios to evaluate how the company is performing and how it has changed over time. They can also be used to assess performance against industry averages or peers.
In this gross revenue vs. cash flows, we use the cash flow-to-revenue ratio or the operating cash flow-to-sales ratio. This ratio uses the values of a company's operating cash flow to revenue. The ratio helps to highlight how well management can turn its revenue into net income and cash flows.
The formula for this ratio is the cash flow divided by the net revenue, then shown as a percent value.
The operating cash flow value can be obtained from the cash flow statement. It can also be calculated by adding net income to noncash items, like depreciation expense and the variance between current assets and liabilities (also known as working capital).
The ratio is helpful for stakeholders, as they can use it to measure the effectiveness of financial management and cost controls. A high operating cash flow to sales ratio usually indicates that the company can make a larger percentage of its revenue into profits and net cash flow.
If the ratio is declining or rising steadily, it shows that the company is steadily losing money, has more money owed, or is gaining profitability, respectively. Weak receivables management and rising costs are some of the leading causes of a declining trend lineIf a company has reported revenue of $ 50,000, and its operating cash flows are $25,000. Its operating cash flow-to-revenue ratio is 50 % [100 x ($25,000/$50,000)].
If the company revenue increases by 10 percent to $55,000 [$50,000 x (1 + 0.10) = $50,000 x 1.10 = $55,000], by spending more on advertisements and packaging to generate this higher revenue, its net income may decline in actuality. This will mean that the operating cash flow will also drop.
Now, if the cash flow declines by 5 percent to $24,700 [$25,000 x (1 - 0.05) = $25,000 x 0.95 = $23,750], the new cash flow-to-revenue ratio is 43.2 % [100 x ($23,750/$55,000)], which is a decline of 6.8 percent (50 – 43.2) in spite of the 10 percent rise in sales.
Should revenue be higher than cash flow?
From all that we've discussed, we know that the cash flow statement reports the additions and subtractions to a business's cash. While that has its importance, revenue shows the money the company makes from its sales and other income-generating activities. A positive cash flow is vital for business health.
Both extremes need to be avoided for a running business. If a business borrows money, it will have positive cash flows, but if it is not generating enough revenue to pay it back, it will end up in problems. Similarly, a business could be earning much revenue but is also using it all up due to financial mismanagement (high expenses) or high debt levels (all income is spent on paying back loans).
In short, gross revenue and cash flows need to be evaluated together to overview a company's financial health comprehensively.
How do you calculate cash flow from revenue?
The net income value for the specific period is the starting point for any cash flow analysis. All cash activities for the period are added or subtracted from this value. As we discussed earlier, these activities are divided into three sections.
Cash flow from operating activities
Cash is the changes in a business's working capital (current assets less current liabilities) listed under this section. Note that these are both short-term items. Accounts receivables (customer bills) that have been collected and accounts payable that have been paid to vendors are also recorded.
Cash flow from investing activities
Cash earned or paid through actions related to long-term assets is recorded under this section and is called investing cash flow—sale and purchases of plant, property, and equipment that involve cash fall under that category.
Investing activities also cover the sale and purchase of long-term assets like vehicles, office furniture,
Cash flow from financing activities
Businesses usually rely on financing their business through debt or capital. Cash generated due to stock issues, bond issues, or bank debt are all listed under financing activities. Examples of cash outflows in financing activities include dividend and interest payments and stock buybacks.
Since cash flows report both the inflow and outflow of cash equivalents into a business, it can be a negative value. It can show small business owners that they are not generating cash despite sales. It is always ideal to have positive cash flows. A positive cash flow means that the business is in good financial health. It is not possible that Gross Revenue can show a negative number.