A trader sells goods worth ₦500,000 in one month, and of course, she’s excited because she has never sold that much before. She tells her friends that business is growing, pays for more stock and takes some money to settle a few personal expenses.
A few days later, she needs money to buy more goods, but the money is not there. She begins to wonder what happened to all the money she made.
Wait… she sold more than ever, yet she is struggling to keep the business running.
This is where many business owners make a costly mistake, they see money coming into the business and assume that they are making money.
But the money your business receives from sales is not the same as the money your business earns as profit.
Sweetheart, come closer, let me tell you… understanding this difference can change the way you run your business.
1. What Is Revenue?
Revenue is the total amount your business earns from selling its products or services before deducting the costs and expenses of running the business.
If you sell 100 bags at ₦5,000 each, your revenue is ₦500,000, assuming all 100 bags were sold at that price and there were no returns or other adjustments.
That figure tells you how much you sold, but it does not tell you how much you made as profit.
2. What Is Profit?
Profit is what remains after you subtract the relevant costs and expenses from your revenue.
Let us return to the trader who sold goods worth ₦500,000.
Suppose she spent ₦300,000 purchasing the goods she sold, ₦20,000 on transportation, ₦15,000 on packaging and delivery expenses, and ₦25,000 on other business expenses.
Her calculation would look like this:
Revenue: ₦500,000
Total expenses: ₦360,000
Profit: ₦140,000
For this simplified example, we have assumed that all relevant costs have been accounted for. In an actual business, she would also need to consider any other applicable expenses, taxes and costs that have not been included.
The important lesson is that she did not make ₦500,000 in profit, she generated ₦500,000 in revenue and had ₦140,000 remaining after the stated expenses.
There is a big difference between the two figures.
3. Why a Business Can Make More Sales and Less Profit
Imagine that you sell clothes and make ₦200,000 in profit in January.
In February, you decide to attract more customers by reducing your prices. As a result, your sales increase, and you generate ₦350,000 more in revenue than you did in January.
You are pleased because the business appears to be growing.
However, you have also spent more on transportation, advertising and deliveries. After calculating your expenses, you discover that your profit has fallen to ₦150,000.
You sold more but earned less profit.
This can happen when the cost of generating additional sales is greater than the additional money those sales contribute towards the business.
It can also happen when you offer discounts that reduce your earnings on each item without selling enough additional items to compensate for the reduction.
This is why you should never judge the success of your business by sales figures alone.
Revenue tells you how much business you are doing, but profit tells you whether the business is earning more than it spends, after the relevant expenses have been accounted for.
Of course dear, both figures matter, but they answer different questions.
4. Why the Money in Your Account Can Mislead You
There is another important lesson to learn:
Profit and cash in the bank are not the same thing either.
Suppose your business makes a profit of ₦140,000, but you use ₦100,000 to purchase additional stock for future sales, and you also withdraw ₦30,000 for personal use.
You may now have only ₦10,000 left from that profit in the money you have set aside, even though the business has not necessarily lost the remaining amount.
Some of the money has been used to purchase stock, and some has been withdrawn for personal use. You must account for those transactions properly to understand the business’s actual financial position.
The timing of payments also matters. You may record a sale to a customer who has not paid you yet, depending on your accounting method. That sale may contribute to your revenue, but the money is not yet available to pay your suppliers.
This is why business owners need to keep proper records of sales, expenses, stock, money owed to them and money they owe others.
Do not assume that a healthy bank balance automatically means that your business is profitable. Equally, do not assume that a low bank balance means that the business has made a loss.
What you should do is to find out what the figures actually mean.
5. What You Should Start Doing Today
If you want to understand the financial position of your business, begin with these three steps:
First, record every sale. Know how much your business generates each day, each week and each month. Do not rely on your memory or the money entering your account.
Second, record every business expense. Include the cost of the goods you sell, transportation, packaging, rent, advertising, staff expenses and other relevant costs. If you withdraw money for personal use, record that separately rather than treating it as an ordinary business expense.
Third, calculate your profit regularly. Compare your revenue with the costs and expenses associated with earning it. Review the figures to see whether your business is improving, whether your costs are increasing and whether your prices are still sustainable.
You do not need to wait until your business becomes large before you start doing these things. A small business needs proper financial records just as much as a large one does.
In fact, understanding your figures while the business is still small can help you identify problems before they become difficult to correct.
What I Want You to Think Carefully About as a Business Owner
Let’s say there are two traders, and the first sells goods worth ₦1 million in a month but makes only ₦80,000 in profit.
The second sells goods worth ₦600,000 but makes ₦150,000 in profit.
Which trader has the better business?
Revenue alone would make the first trader appear more successful. However, profit tells a different story, although other factors, including cash flow, business risks and the prospects for future growth, must also be considered before making a complete assessment.
The first trader may need to examine costs, prices and the way the business operates. While the second may have found a way to generate a stronger return from a smaller volume of sales.
This is why business owners must learn to look beyond the amount of money coming in.
Do not be satisfied simply because your sales are increasing. Find out how much it costs you to generate those sales, what remains after your expenses and whether the business is becoming financially stronger.