Revenue vs. Profit – Where is Your Focus?
What’s not to like about the Colorado economy? Revenues for many companies have been growing over the last several years and may be attributed to various factors:
- Customers are more abundant
- Capital to grow your business is available
- A highly educated workforce exists
So what’s the problem? Life is good! As usual, I like to look a little deeper into revenue and profitability. As a business fundamentalist at heart, most of my work with small to mid-size business owners is about implementing the financial fundamentals to maximize their profitability and cash flow.
We all know that revenue is critical to a company’s operations. Without it we can’t produce profit and cash flow. And all businesses require a certain level of revenue to support their business model of operating expenses. But once we achieve that level of revenue, we must focus on profitability in order to grow. Profit creates the cash flow to reinvest into your company to continue to grow the revenues. Yet low profitability or losses with high revenues will make growth more challenging or futile.
Let’s look a couple of examples of companies that are growing their revenues but have different focuses:
Revenue-Focused Company
Revenues – 2016 $3,000,000 100%
Cost of Goods/Services Sold 2,000,000 67%
Gross Profit 1,000,000 33%
Overhead & Expenses 850,000 28%
Net Profit $ 150,000 5%
Revenues – 2021 $8,000,000 100%
Cost of Goods/Services Sold 5,360,000 67%
Gross Profit 2,640,000 33%
Overhead & Expenses 2,000,000 25%
Net Profit $ 640,000 8%
This certainly seems acceptable; $420,000 will provide a good living and fund retirement when you are ready to sell. Let’s look at another example where the company focused on profitability first:
Profit-Focused Company
Revenues – 2016 $2,500,000 100%
Cost of Goods/Services Sold 1,550,000 62%
Gross Profit 950,000 38%
Overhead & Expenses 750,000 30%
Net Profit $ 200,000 8%
Revenues – 2021 $4,500,000 100%
Cost of Goods/Services Sold 2,700,000 60%
Gross Profit 1,800,000 40%
Overhead & Expenses 1,125,000 25%
Net Profit $ 675,000 15%
Since there are a lot of numbers to consider, let me highlight the key points:
- The Revenue-Focused Company grew to $8MM with a respectable $640,000 net income
- The Profit-Focused Company only grew to $4.5MM with an exceptional $675,000 net income
- The Revenue-Focused Company has more customers, more customer service issues, required more products/services to deliver, had more employees in their organization (even with technology improvements), and overall a more complex business to manage
- The Profit-Focused Company has fewer customers and customer service issues, delivered fewer products/services with higher margins, and has fewer employees plus a happy business owner with a work/life balance (my interpretation!)
This is a fairly typical tale of two companies with a different focus and roughly the same net income. The Revenue-Focused Company will have difficulty continuing to grow at the same pace. Why? Because the net income and cash flow will make it difficult to reinvest in their growth to support a larger infrastructure. Potentially, the proverbial “running out of cash while revenues are growing” problem will plague this company.
On the other hand, the Profit-Focused Company could grow at a faster rate since their profitability and cash flow is more than sufficient to grow their business. If they achieved $8MM in revenues, and assuming the same net income percentage as 2021, they would generate $1,200,000 in net income. When the business is ready to be sold (all other issues aside) assuming a selling factor of 2.5 times net income:
- The Revenue-Focused Company would sell for $1.6MM ($640K x 2.5)
- The Profit-Focused Company would sell for $3MM!
The difference is a matter of fundamental financial focus. Where is your focus?
