Revenue, profit, and cash

Overview

Harbor Repair’s owner finishes September pleased with sales. The company earned a profit, yet its bank balance fell. Before hiring another technician, she needs to understand where the money went.

Harbor Repair is fictional. All figures in this lesson are synthetic.

Recall Lesson 002: ClearFlow billed customers after providing maintenance and waited another 30 days for payment. What did that require ClearFlow to fund in the meantime? Answer briefly before reading on; the debrief includes the answer.

Revenue, profit, and cash

Revenue is the amount earned from providing goods or services during a period. For today’s examples, the work is complete, the customer accepts it, and the agreed payment is expected to be collected.

Expenses are costs counted against that period’s revenue, such as labor used to perform the work and rent for that month. Profit is revenue minus expenses. If expenses exceed revenue, the business reports a loss.

We use accrual accounting: record revenue when earned and expenses when incurred, even if payment happens later. Cash-basis accounting uses different timing. These examples teach accrual principles, rather than selecting an accounting or tax method for a particular business. Source: OpenStax.

Cash means money available, including bank deposits. The cash balance is measured at a particular moment. Cash flow measures money moving in and out over a period. The income statement reports revenue, expenses, and profit; the cash flow statement explains changes in cash. Source: SEC.

Use three equations:

• Revenue = completed units sold × price per unit, when every unit has the same price.
• Profit = revenue − expenses for the same period.
• Ending cash = beginning cash + cash received − cash paid during that period.

An invoice requests payment. Sending it does not, by itself, establish that the work was completed or that money arrived. Always check what happened and when.

Worked example

Harbor completes and invoices 10 repair jobs at $1,000 each. Customers pay $4,000 during September; the remaining $6,000 is due in October. September expenses total $6,000, all paid during September. Harbor starts with $5,000 in cash.

For simplicity, these are all September transactions. There are no opening unpaid customer invoices or bills, loans, equipment purchases, owner withdrawals, or income taxes. The $6,000 includes all expenses in this simplified example.

First calculate revenue: 10 jobs × $1,000 per job = $10,000.

Then calculate profit: $10,000 revenue − $6,000 expenses = $4,000.

Then calculate cash: $5,000 beginning cash + $4,000 received − $6,000 paid = $3,000 ending cash.

Harbor earned $4,000 while its cash fell by $2,000. Customers still owe $6,000, called accounts receivable. Harbor has earned a claim to payment but cannot spend that claim like money in the bank.

Check the connection: $4,000 profit − $6,000 increase in receivables = −$2,000 cash change. This shortcut works here because we excluded other differences between profit and cash.

When customers pay the $6,000 in October, cash increases and receivables decrease. Harbor does not earn that same revenue again. If a customer ultimately cannot pay, Harbor must account for that loss; the example assumes full collection.

Planning cash needs

The owner needs a dated list of expected collections and upcoming payments before hiring. A positive monthly profit does not establish that enough cash will be available on payday.

She could seek deposits on future jobs, shorten agreed payment terms, follow up promptly on overdue invoices, or arrange funding. Each choice has consequences: customers may resist deposits, and borrowing creates repayment obligations and interest costs.

A loan increases cash without creating sales revenue. Repaying the amount borrowed reduces cash without being an operating expense; interest is a separate expense. Likewise, owners putting money into the company increase cash without creating revenue.

Timing can also work in the other direction. A customer may pay before the business performs the service. Under accrual accounting, collecting that advance does not automatically mean the full payment has been earned.

We will add inventory, equipment, and other complications later. For now, distinguish work performed, expenses incurred, and actual payments.