The term “growth” in business spurs images of financial statements — items such as cash, assets, profits, and liabilities. While these on-balance sheet are fundamental to revenue growth, they ignore the biggest driver of all: off-balance sheet items, or items not listed on financial statements. For example, an e-commerce website’s loyal customers and strong relationships with suppliers are core revenues drivers, but these don’t get recorded financially.
In short, revenue drivers include on-balance sheet items such as cash, assets, profits, and liabilities, as well as off-balance sheet items such as loyal customers, good suppliers, and industry-specific dynamics.
In Benjamin Graham’s The Interpretation of Financial Statements, the legendary author devotes a one-page chapter to this very idea. The “earning power of a company,” he says, depends largely on off-balance sheet dynamics, or “the earnings that may reasonably be expected over a period of time in the future.”
This article explores the 5 key revenue drivers, with particular attention to off-balance sheet items, which vary by industry:
- Cash
- Assets
- Profits
- Liabilities (but not equity)
- Off-balance sheet items such as customer loyalty
NOTE: this article is not about growth drivers through and through. Growth as a concept includes revenues drivers AND cost drivers. Here we’re only interested in top-line growth — revenue.
Cash as Revenue Driver
A company has cash in the bank just like you and me. Whenever a company uses its cash to buy assets that generate more money, then we can say that this cash is a revenue driver.
For example, think about your life. If you are able to save some money when you’re young, you hear people talk about investing it. You might buy a house, which increases in value over time. You might buy stocks or bonds, which increase in value over time. Alternatively, you might buy a car, which decreases in value over time. However, that car allows you to drive to your job, which generates more cash for you.
Cash is a revenue driver to the degree that it permits the purchase of assets that generate more cash. At the same time, it’s the ultimate goal of revenue growth.
You can think of cash as a tool and a product of revenue growth — the ultimate investing revenue driver. As the old adage goes, “cash is king.”
Assets as Revenue Driver
Assets drive revenues insofar as they are used to generate them. Revenue-driving assets include quick, liquid goods such as inventory and accounts receivable, as well as heavy items such as land, factories, and machines.
Assets have two categories: 1. assets to buy and sell for profit, and 2. assets that generate revenue. In our personal lives, most assets fall into category 1. The house we buy and stocks we purchase are supposed to grow in value over time so we can make money by selling them later.
In a business, assets can be used to produce goods that are then sold for revenue, OR assets can be bough and sold for profit. For example, imagine a watch making company that buys two main assets: metal for its watches, and a big machine to bend that metal to the right shape.
The metal itself generates revenues because we use it as part of the product — it directly drives growth.
The machine does the same. It’s used to produce the watches, thus driving revenues. At the same time, it can be sold at a later date to generate cash (not revenues). And as we’ve seen, cash can further drive revenue!
In this way, many heavy assets generate revenue and can be sold for profit. In your personal life, your house also provides you with shelter so you can go to work to generate more revenue.
NOTE: the difference between assets that generate revenue and those sold for profit is subtle: revenue-generators are related to company operations, while gain on sale is just a cash transaction. Gain on sale does NOT impact revenue. However, it does provide cash that can be used to generate more revenue, as discussed above.
Profit as Revenue Driver
Company profits drive revenue when they are reinvested in the company. In other words, they are cash that can be used to buy more revenue-generating assets.
There’s a subtle difference between cash and profit, and you’ll need to understand it for this section.
Most people have a false supposition about profits. They envision them as money sitting in a company after paying its costs during a 1 year period. In this view, profit is linear and stable during the 1-year period.
In reality, profits do not become cash right away, and they’re usually reinvested through the year as needed. These nuances are called accounts receivable and reinvestment, respectively.
Accounts receivable simply means that customers do not pay for products right away — they have 30 days or so. The company, thus, records a sale (the product is delivered), but does not receive cash right away (accounts receivable).
Reinvestment occurs on an irregular basis as well. Perhaps a company needs to use proceeds from a recent sale of products to buy more inventory. While the revenue from that sale ultimately gets recorded as profit on the books, that cash has not been kept in the bank.
It’s only at the end of the year that accounts receivable and reinvestments amounts can be consolidated, and that the remaining profit can be called available cash.
In sum, the cash reinvested throughout the year and the remaining amount at year end are used to purchase revenue-generating assets. This is how profits generate revenue.
Liabilities (not equity) as Revenue Driver
Liabilities generate revenue insofar as they fund the purchase of revenue-generating assets.
Common liabilities include bank loans and accounts payable. A loan provides cash inflow, which can then be used to purchase, say, inventory (such as metal for our watches) or machines (such as metal-bending machine for our watches).
Accounts payable is a short-term liability (due within 1 year) that represents the sum of money we have not yet paid for goods we have already received. It’s cash that we will eventually need to pay, but that we can use elsewhere for now.
While loans and accounts payable represent cash, this is only the case before they are due. Both require payments on a regular basis. Loans have monthly payments and accounts payable usually have 30-day turnover, which means to use cash from them requires strict cash-flow oversight.
In my opinion, liabilities are the weakest revenue driver. Since they require more cash-flow oversight than the other revenue drivers, there’s added operational stress to cash from liabilities. At the same time, they are critical for companies that don’t have enough cash flow from operations.
Equity as Revenue Driver – It’s Not
The funding counterpart to liabilities is equity — the money that shareholders contribute directly to the company. While this activity supplies cash that can then be used to buy revenue-generating assets, I do not consider it a revenue drive because it does not have a regular impact on the company.
In theory, shareholders can contribute an endless supply of equity to a company that generates extreme losses. But who would say that this is a revenue generator? Liabilities such as loans put pressure on shareholders and business decision-makers to perform well, lest they go into default. Equity contributions, however, carry no such pressure.
In fact, equity can be the opposite of revenue generators — revenue depleters.
Off-balance sheet items as Revenue Drivers
Off-balance sheet items are the ice road truckers of revenue drivers. They consist of qualitative factors that bring value to customers and business relationships, which vary greatly by industry. Examples include business relationships, value propositions, loyalty, and brand recognition, among many others.
Let’s look at two industries to concretize the concept of off-balance sheet items and their role in driving revenue.
- E-commerce marketplaces (i.e eBay)
- Train companies
E-commerce marketplaces (i.e. eBay)
What are they? E-commerce marketplaces host commercial transactions for buyers and sellers, often in niche markets. eBay is an example of a non-niche marketplace because it hosts transactions for all kinds of products.
What value do they bring to the table? They bring value to these exchanges by providing a common place of exchange, allowing users to buy and sell at a distance, and securing payments to protect users from fraud.
What dynamics in individual marketplaces drive revenue? Revenue-driving metrics in marketplaces are:
- Number of buyers and sellers. The absolute number of buyers and sellers improves not only the total number of exchanges, and thus produces a higher revenue, but also increases the chance that buyers and sellers feel like the platform fulfills their needs. The more fulfilled customers are, the more likely they are to stay.
- Product supply and demand. While eBay provides a seemingly endless number and type of product, some marketplaces specialize. The goal for these platforms is to have a near-perfect supply and demand of valuable, quality products. For example, a marketplace for used cars aims to have a the right amounts of many different types of car. This way, buyers are more likely to purchase.
- Average spend per user. The beauty of e-commerce platforms is that they can track users by user ID. This means companies know how much users spend during a one-month period. The goal is to have each user spend more by optimizing supply & demand, the total number of users, and perhaps most importantly, the user experience.
- Customer lifetime on the platform. Customer lifetime, often referred to as customer churn, or customer retention, signifies the amount of time that most customers are active on a platform. Definitions of “active” vary by marketplace, but the point here is simple: the longer customers stay on board, the more revenue they generate.
Train companies
What are they? Train companies own and operate the trains that run on public railways.
What value do they bring to the table? Train companies help travelers get to major destinations faster than cars (they’re more common in Europe than the US today). Individual train companies set themselves apart by offering a mixture of luxury/commercial experiences, various destinations, and attractive prices. Most travelers prioritize destinations, then pricing, then experience.
What dynamics in individual train companies drive revenue? Revenue-driving metrics in train companies include:
- Destinations provided. The number of good destinations available dramatically increases the value of a train company, and with that value, its revenue. The trick is, all of these companies compete for the best locations. Good train companies are the ones who strategically plan their cash to accept services quality locations at a low price. This may sound counterintuitive: how can servicing high-quality destinations generate more revenue? Because good destinations increase the overall value of your brand, which will lead to more sales in other locations. In other words, they increase the value of their brand.
- Quality of train cars. In addition to destinations served, the quality of train cars can improve brand value. If the experience of riding in your train is better than riding in competitor trains, and customers recognize the value of destinations your serve, your train company will generate more revenue.
- Number of travelers. The culmination of a various destinations and quality trains is brand value. But brand value isn’t the end game. Ultimately, what train companies want are valuable, loyal customers. The more customers buy and return to buy more, the more revenue they generate.
