Check out my description of the best type of revenue…
VIDEO SUMMARY
Last week I made a video about Revenue, and this week I wanted to go a little bit deeper. Now if you are involved in building a marketing plan or a sales strategy, you know that it can be a very complicated subject. A lot goes into it. People spend entire careers studying marketing. I don’t claim to be an expert in marketing, but I am an expert in accounting. So I want to talk about revenue from an accountant’s perspective. There is one central concept about Revenue that is very powerful to understand.
The concept I want to cover is “Not all revenue is equal.” This is basically saying that there are different types of Revenue. To put this another way, $1 of one type of revenue is not equal to $1 of another type of revenue. Just stop an think about how significant this is. $1 is not equal to $1 when you look at the money coming into your business.
So to understand what this means, let’s first look at three different types of revenue:
- First time customers
- Repeat customers (variable revenue)
- Repeat customers (fixed revenue)
The different between first time customers and repeat customers is fairly obvious. You are going to have customers who are buying from you for the first time, and then you are going to have customers that keep coming back and making purchases at your business. But then when you look at repeat customers you need to break it down even further. Variable means the revenue goes up and down each quarter and you have no guarantee of what it will be. So you have customers coming back, but you don’t know how much they will spend each time. Fixed revenue typically comes from some agreed upon contract with the same level of revenue each quarter.
So those are three different types of revenue. Now if you ask any business owner, they will tell you this list is in order of preference. Repeat customers generating a fixed revenue source is the most attractive. So the order of preference is first time customers, Repeat customers with variable revenue, and Repeat customers with fixed revenue.
There are three reasons why Fixed Revenue is attractive:
- PRACTICAL. There is a practical reason why fixed revenue is so attractive, is it makes so many things in running your business easier. If you are planning out your year ahead, and you know you have a fixed level of revenues coming in, it makes planning much easier. Compare that to the situation where you have no idea how much revenue will come in. It is much more difficult. How do you hire staff, when you can’t guarantee you will have the revenue to pay them? In fact, fixed revenue is so valuable, that many businesses will discount their prices to lock in guaranteed revenue contracts.
- FINANCIAL. There is an actual financial reason why fixed revenue is more attractive. Fixed revenues are less risky than variable revenues. So I made a whole video series on Finance. It’s 6 hours of videos. If you watch those videos, what you will discover is that Finance is all about risk. It is about understanding risk, managing risk, and valuing risk. In fact, a company’s level of risk drives that company’s valuation and stock price. So if your company relies in on variable revenues instead of fixed revenues, that will impact your stock price. I will give you a simple example of how this plays out. If you go to a bank and ask for a business loan, one of the things they will look at is your types of revenue. And if they are comparing two different businesses, the one with fixed guaranteed revenue is going to be less risky than the one with completely variable revenue. And so the bank is going to give a lower interest rate to the less risky business. That is just one example, but there are many different ways the type of revenue has a financial impact on your business.
- PERSONAL. We also need to look at this from a personal perspective. There is a human element to what is going on. This list of types of revenue follows the same pattern of a customer’s experience. The more mature your customer relationship, the further you can move them along this scale. A first time customer has a higher hurdle to signing a long-term contract, because they do not know you that well. So it may take doing business a few times to feel confident in signing that long-term agreement. So there is a sales progression where you want to move your relationship along this scale. And that means you are providing more and more value to your customers, so much so that they want to lock in their agreement with you. It is a win-win for both parties.
So in reality, every business has all three types of revenue. You have first time customers. Those customers turn into repeat customers. Those customers turn into fixed revenue contracts. We talked about how that plays out from a practical perspective in planning your operations. We talked about the financial perspective in valuing your business. And we talked about the personal perspective in managing the relationships with your customers. I like to talk about this idea, that not all revenues are equal, because it affects all kinds of decisions you make every day in your business.
I just want to add one more clarification. I am not suggesting you treat your customers differently. Each customer relationship is equally important to the health of your business. All I am suggesting is to understand the financial perspective, and when you go to a bank, they will put a value on the difference between different types of revenue.
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Neither Zach De Gregorio or Wolves and Finance Inc. shall be liable for any damages related to information in this video. It is recommended you contact a CPA in your area for business advice.