The words ‘profit’, ‘turnover’ and ‘revenue’ are often misunderstood.

Ponder this:

• How can a business making a ‘profit’ go bankrupt?
• How can a company with £1 million in ‘revenue’ receive no cash during the year?
• How can a company with a turnover of £5,000 make a profit but a company that turns over £1 billion make a loss?

We can answer these questions using some very simple accounting terms. In the world of accounting, revenue (another word for ‘turnover’) is recognised at the time of sale. If I sell you an apple today for £5, the taxman will conclude that I have earned £5 in ‘revenue’ today, regardless of whether you pay me the £5 now or 6 months from now. In this scenario, revenue was not a result of receiving cash, but a transaction that is expected to turn into cash sometime in the future (when the customer pays). By the same logic ‘profit’ does not equate to cash either.

Let’s go back to the apple example.

I have £1,000. Then I buy 1,000 apples with my £1,000. Next I sell all 1,000 apples to John for £5,000. Finally I give John an invoice for £5,000 and he tells me he will pay me next week. Now let’s do the accounting: I earned revenue of £5,000 and incurred expenses of £1,000, giving a profit of £4,000. However I spent my £1,000 on the apples, and haven’t received payment from John yet. How much cash do I have? ZERO!

Revenue £5,000

Expenses £1,000

Profit £4,000

Cash £0

Keep this in mind next time you hear the words ‘profit’, ‘revenue’, ‘turnover’ and ‘cash’. Just because someone makes a profit does not mean they have cash in their pocket. Just because a company has a high turnover doesn’t mean they make a profit. Understanding these terms will help you improve your financial literacy. Colour Accounting™ is our financial literacy course. Discover how this awesome finance for non-finance managers course will change the way you think about finance.  ]]>