Revenue Growth vs Profit: Choosing Your Business Financial Strategy
Guest Post: By Dhosjan Greenaway-Dalini
Emerging e-commerce businesses often face the dilemma of choosing between focusing on revenue growth or prioritising profit. As an owner of an e-commerce company, there’s huge pressure to strike the right balance, since the choice you make will impact your business’s progress, cash flow, and long-term sustainability.
It’s important to take the right approach to growth strategies, but this will depend on your access to funding, market conditions, and any future plans for growth. In this blog, we’ll explore the pros and cons of revenue-first versus profit-first strategies, to help you choose the right one for your business.
So, to start, what is revenue growth, and why does it matter?
The Revenue-First Strategy
Revenue growth refers to the increase in sales revenue over a specific period. This growth can be monthly, quarterly or annually.
Businesses using revenue-first strategies focus on expanding and growing quickly, even when they may not be able to see instant profit or financial results. This method tends to be popular with venture-backed companies, which receive funding from investors that expect the business to perform well.
Revenue-first management prioritises collecting customers, market penetration (this phrase means getting as much of the available target market as possible using your product), and brand visibility. This approach essentially means trying to expand quickly and gain a foothold in the market, even if the business ends up operating at a loss to start with.
Pros:
- Market Domination: Gaining customers quickly can establish your company in the target market.
- Investor Attraction: High growth rates attract investors seeking high returns, as this often signals the potential for significant future profits.
- Economies of Scale: Initial rapid growth can lead to an ‘economy of scale’ – this is when expanding your business can help you save on average product costs, e.g. due to bulk discounts. Over time, this can help you become more profitable.
Cons:
- Risk of Cash Burn: High growth often leads to more expenses, such as paying for staff salaries, customer service tools, and improved marketing. Without enough funding, revenue-first businesses may struggle to maintain their growth or even stay in business.
- Delayed profitability: Making profit is often delayed until the future, which can leave your business in difficulty if market conditions change or funding sources dry up.
Profit-First Strategy
Profit and profit margins refer to the amount the business keeps from each sale after expenses. (Example: A 50% profit margin means you keep 50p for every pound earned through sales. This is better than a 10% profit margin, where you would keep only 10p per pound.)
This type of strategy focuses on financial stability and a streamlined, self-sustaining operation. It involves maintaining healthy profit margins, without needing to rely on external funding, which is why this approach is popular with non-venture-backed businesses.
However, many venture-backed businesses have started to use profit-first strategies, in response to the recent financial crisis and economic uncertainty.
Pros:
- Financial Stability: By focusing on profitability from the outset, businesses gain the means to finance their own operations. This creates a solid financial foundation, and reduces the risk of running out of cash.
- Sustainable Growth: This approach allows for controlled, sustainable growth that does not overstretch resources, making the business resilient against market downturns.
- Better Margins: A focus on generating healthy profits encourages efficient operations, cost control (which means reducing expenses to increase profits), and better pricing strategies, leading to healthier margins.
Cons:
- Slower Expansion: A profit-first strategy can limit growth potential, especially in highly competitive markets where speed is crucial to success.
- Missed Market Opportunities: Businesses may miss out on capturing a larger market share quickly, which can give competitors a chance to dominate.
E-commerce Profit Margin Benchmarks
There are two types of profit margin benchmarks: gross and net profit. We’ll give you a quick breakdown of each and explain what it means for your e-commerce business.
Gross Profit:
This metric shows your revenue from sales minus the cost of goods sold (COGS). COGS refers to the money spent on making your products, which may include product components or packaging. This number will also differ depending on how many sales you make in a given period.
Gross profit margin does not factor in all operating costs, but gives you a quick view of your financial health. A healthy gross margin indicates efficient operations and strong pricing strategies. For e-commerce businesses, 45% is generally considered a good margin.
Net Profit:
This metric shows whether your business is still profitable after accounting for all expenses such as COGS, operating costs, and taxes. This gives a more accurate picture of the money your business has left to spend.
Net profit is usually much lower than gross profit, since it takes more expenses into account. A 10% net margin is considered average for e-commerce, but this can vary. While 5% is considered low, high-performing businesses can achieve a net margin of 20% or more.
In summary…
Both revenue-first and profit-first strategies have their benefits and drawbacks, so finding the ideal approach for you will depend on where you are right now, and what you want to achieve. Besides, the right strategy for you may also change as your business grows and develops over time.
It’s important to balance the benefits of expanding quickly with the need for stable and sustainable finances. Understanding your profit margins, target market, and other metrics can help you choose how to proceed, but working out how to meet the needs of your business can be difficult, especially when running a company on your own. So we’ve created a solution to help you understand your business and get to grips with your finances.
CloudFO, your AI finance colleague, is a friendly and personable business finance tool, designed to help you understand your company’s performance and empower you to make informed financial decisions, like choosing whether to use a profit- or revenue-first strategy.
Link your Shopify storefront up, and let CloudFO seamlessly integrate across a range of apps, such as Shopify, Xero and Stripe, to give you up-to-date analysis, and answer any questions you might have about your finances. Our process is quick and accessible, instead of endless and repetitive cycles of corporate meetings. And if you time it right, you’ll be able to finish your weekly finance review before your coffee goes cold.
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Before you go, why not check out these related articles?
https://blog.cloudfo.co/financial-insights-for-decision-making/
https://blog.cloudfo.co/streamline-your-cash-flow-management-with-cloudfo/
