Between Revenue and Expenses: The Principles of Growth

A business sells more this year than it did last year. On the surface, that sounds like excellent news. Revenue is up, more customers are coming in, more people need to be hired and the company feels larger.

Then the end of the month arrives, and somehow the bank account feels tighter.

That is the moment many business owners discover one of the less intuitive truths about growth: more revenue does not automatically mean more money.

Growth costs money. Sometimes a great deal of it.

Selling more can require purchasing inventory earlier, hiring employees before the revenue they support arrives, increasing marketing, renting more space, building product or extending longer payment terms to customers. A business can be profitable on paper and still run into a cash shortage.

That is why profit, cash flow and growth need to be connected, but they should never be confused with one another.

Profit tells us what remains from revenue after costs over a certain period under accounting rules. Cash flow tells us when the money actually comes in and goes out. Growth tells us that the operating system of the business is becoming larger. Sometimes all three improve together. Sometimes growth puts pressure on the other two.

Imagine a store selling a product for $100 at a cost of $60. On paper, the margin looks healthy. If sales double, gross profit should rise as well. But if the supplier must be paid in advance while customers pay later, the business has to finance the gap. Every unit of growth requires more cash before it generates more cash.

That is why one of the most important growth principles is understanding what it costs to create the next dollar of revenue.

In startups, this question often appears under the heading of unit economics, but it matters in almost every business. What does it cost to acquire a customer? What does that customer contribute over time? Which costs increase each time another unit is sold? At what point does the business need another employee, vehicle, machine or location?

If growth doubles revenue but triples cost, that is not necessarily success.

CB Insights, in research on hundreds of venture-backed companies that shut down, found that 70% of the companies in its sample ultimately reached the point where they ran out of capital. But the researchers emphasize that this is usually the final symptom rather than the original cause. Weak product-market fit appeared in 43% of the cases, while unhealthy unit economics appeared in 19%. The research covers a particular sample of failed startups rather than businesses as a whole, but the principle is useful: cash runs out at the end. The interesting question is what caused it to run out. CB Insights

A second principle is learning to distinguish investment from expense growth.

Two $100,000 expenses are not necessarily equivalent. One may be a system that cuts production time by 30%. The other may be a larger office rented mainly because the company feels it has “reached the stage” where it should have one. The first expense may create new capacity. The second may simply raise the break-even point.

That does not mean every investment has to pay for itself immediately. Some growth requires a belief in the future. But management should know which assumption the spending is based on and what evidence would tell them that the assumption was wrong.

A third principle is not to confuse frugality with cost strategy. Cutting everywhere can improve one quarter’s profit and weaken the company for the next two years. On the other hand, a business that never re-examines costs can accumulate layers of spending that no longer have any connection to strategy.

Good cost management does not ask only, “Where can we cut?” It asks, “Which expense creates a capability we need, and which expense remains only because it already exists?”

The fourth principle is to build forward. The U.S. Small Business Administration recommends that businesses creating a financial plan include projections for income, balance sheet and cash flow, and that the first year often be modeled at a monthly or quarterly level. Not because a five-year forecast will be exactly right, but because the exercise forces the business to understand what has to happen for the plan to hold together. SBA

Ultimately, good growth is not a business spending less.

It is not simply a business earning more either.

It is a system in which money entering and leaving the company has a reason. If revenue rises, management should understand what is happening to profitability. If margin is being compressed, they should know whether that is a deliberate investment in growth or a problem. And if the business is growing faster than it can finance that growth, management should see it before the bank does.

Revenue makes a business bigger.

Good economics make it stronger.