As part of OnlineAdvisor’s efforts to educate, inform and encourage business leaders, we present key financial terms and concepts. The concept of revenue is an important one. It may be one, however, that is very misleading. Let’s get into the reasons why.
Traditionally speaking, revenue shows the sales you made with your customers. This is usually called “income.” This is considered an important part of business – if you don’t make sales, you don’t stay in business. Therefore, we want to watch these numbers very closely on our income statement. It’s important we are making enough sales to maintain a profitable business.
There is a potentially misleading situation when viewing the revenue section of our companies’ income statement. The accrual method of accounting requires each sale must be posted as revenue. That isn’t a problem as long as payment is collected at the time of the sale.
If customers pay after transactions are posted, our cash flow is affected. We’ve given up the resource we sold, but we haven’t received the cash in exchange for it. Revenue numbers increase, which looks like a good thing. The problem is that we don’t have the money yet. Therefore, we have to watch the cash flow statement to ensure that we will be able to manage current cash demands until we receive payment.
These situations are where customers have “open” or “credit” accounts which allow them to receive goods and services and then pay for them at a later date. These situations can be good for generating additional business, but they put additional demands on our businesses. If we are selling tangible goods, we need cash to replace the goods we sell. If the customer doesn’t pay quickly, our cash requirements rise.
This part of management requires strategic planning and careful control of cash flow. If you choose to provide “open” or “charge” accounts to customers, or if you decide to enter into a market where you can encounter “charge-backs” (transactions that are fraudulent and, as the vendor, you don’t receive the goods back that you sold), you need to plan accordingly that revenue data doesn’t always match the cash amount in the bank.
Someone made this observation: “a sale isn’t a sale until it is paid in full.” The smart business leader knows this fact.
Always work towards receiving 100% payment on 100% of your sales.