[vc_row css=”.vc_custom_1548289356400{background-color: #bcbcbc !important;}”][vc_column][vc_single_image image=”4631″ img_size=”full” alignment=”center”][vc_column_text css=”.vc_custom_1753490080224{padding-right: 19px !important;padding-left: 19px !important;}”]Cash is king in a business and without cash it would be like Kryptonite was to super man. It will kill your business. Understanding cash and how it moves in and out of your business is a fundamental step for business success. Yet few business owners understand cash flow or produce a cash flow projection and play a guessing game with their business.[/vc_column_text][/vc_column][/vc_row][vc_row][vc_column][vc_column_text css=””]
Chapter 10: Know Your Cash Flow
The cash flow projection is the only tool or scoreboard you have that looks ahead at what is coming in your business so you can forecast your cash needs. If you do not have cash flow, you do not have a business.
Business owners often think that net income on the bottom line of the P&L is cash, but it is actually only the theory of cash since the P&L does not account for debt payments (which are a use of cash). This highlights the need for a cash flow projection, which takes your debt payments into account.
It is no surprise that all businesses need cash to survive. Inadequate cash flow is like kryptonite to Superman; without cash your business will suffer and eventually die. Yet most business owners I meet are not tracking their cash flow. They look at their P&L and balance sheet, but they do not conduct a cash flow analysis of their business. Instead, they are managing from their checkbook.
Revenue + Expenses = Profit
Too often business owners look at net income or profit and think they are making money. Your profit is simply the amount that your revenue exceeds your expenses; it is not cash but the theory of cash since your P&L does not take into account debt service. The interest payments are accounted for, but not the debt payments, so it is easy to misunderstand how much cash you have by just looking at the P&L. You cannot spend the theory of cash, and profits are not cash. It does not matter how much profit you make if the amount of cash you receive is less than or equal to what you are spending. If you cut into your cash reserves long enough, you will eventually be broke.
Cash flow is the net amount of money that is flowing in and out of your business, and a cash flow analysis focuses on the timing of when cash comes in and when it goes out. The cash flow projection is the only tool or scoreboard you have to look ahead, and the future is where we want to go. By understanding your cash flow and how it can positively or negatively impact your business, you can make more informed decisions about how to run your business.
An important note about cash flow is that accounts receivable is not cash. There have been many businesses that have gone bankrupt with lots of accounts receivables on their books, but no cash to operate on. As you know, without cash, you cannot pay your bills. The only way to sustain your business is with positive cash flow. Sure, you can borrow money, and that is one form of cash, but it comes with a debt that you will owe. Or you can invest cash into the business to keep it afloat, but eventually you will run out of cash from investment and the ability to borrow more cash will be dependent on cash from operations.
The Value of Metrics
I like to take the financial information to another level and perform metrics on the line items within the financials. One of those helpful metrics is cost of goods sold (COGS), which is a calculation of all the costs involved with producing and selling your product, including materials, labor, warehouse space, and overhead to produce and manufacture the products you are selling. This has serious business implications. For example, I had a client who was complaining that while he made more money in 2017 than he did in 2016, his net income was a loss and he did not understand why. By doing some financial metrics I discovered that his cost of goods sold (COGS) for 2017 was over 12 percent higher than 2016, so right away he was over 12 percent behind last year’s potential profit.
As a business owner, you should be performing a deep dive into your financials and performing a line item analysis as a percentage. For instance, what is COGS as a percentage of revenue? How does this compare to previous years? What is each line item of expense as a percentage of gross profit, and how does this compare to previous years? By doing such analysis we can start to develop trend lines of performance. By following the trend line, you can see how you are doing in comparison to previous years and months. This allows you to ask better questions in order to make better decisions, rather than waiting until the end of the year for a big year-end surprise. Here are some questions you should be able to answer:
- What is your revenue per employee?
- What is your revenue per square foot of space?
- What is your expense per employee?
- What is your expense per square foot of space?
- What is your current ratio, quick ratio?
- What is COGS as a percentage of revenue?
- What is payroll as a percentage of gross profit?
In business, that which we measure gets addressed and improves. Many business owners do not have these answers about their businesses. If you do not, you are not alone, but it is time to change things.
CPAs and Bookkeepers
I was working with a food processor and noticed that all the goods they purchased to make their product were categorized as an expense rather than cost of goods sold. When I inquired as to why there was no COGS category, the business owner said he did not know. He said that is where their bookkeeper put them. I asked who their bookkeeper was and I was told it was a family member. I asked about their CPA because the CPA should have caught it as well. The owner explained that they had been with their CPA for years and he had never said anything. I let the business owner know that they needed a new bookkeeper and a new CPA because their current professionals were just filling in the blanks rather than advising them on how to manage and run their business. They needed better information, which would allow them to ask better questions and make better decisions.
The information needs to be accurate or you are in jeopardy of making faulty decisions based on inaccurate information. I have discovered that many CPAs and bookkeepers are not advising their clients. They are just filling in the blanks. Which one do you have? Accurate financial information and analysis is one of the keys to a successful enterprise.
Success Steps
- Pay close attention to your P&L and balance sheet. Review them on no less than a weekly basis.
- Create a rolling six-month cash flow projection.
- Drill down deeper into the financials and develop some metrics to measure your performance.
- Ask your CPA and bookkeeper to take an advisory role and help you understand your financials.
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Fundamental Steps to help business owners learn what it takes to grow their business and increase their revenue.
As the former GM and COO of a $40 million company with seven locations I have learned what it takes to be successful in business. In this book, I share some keys to sustainable business growth and acceleration and the way to close the gap between your performance and your dreams.
You didn’t go into business to just get by, you got into it to succeed. Follow our series on the website and get your desktop reference copy from Amazon.[/vc_column_text][vc_single_image image=”4271″ img_size=”full” alignment=”center”][vc_column_text]
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