All to often small businesses obsess on how much money they’re going to make, the total number of clients, and how much profit they’ll generate. What they lose sight of is the important third leg of the business stool, day-to-day cash flow; doing so almost always guarantees major problems whether the business is big or small.
Before we journey down this path of discovery lets make sure that we’re in sync with our terms. I tend to not to say “income” because term often means different things to different people. When I refer to “revenue” I’m talking about the money earned from the sale of a product or service. “Profit” is the money left after all the expenses associated with a sale, or sales over a period, are subtracted.
Death by Revenue
With 80% of everything one hears in business focused on structuring, nurturing, and growing the top and bottom-line there is no question as to why it dominates one’s thoughts. Of course, as a business it is vital to have clear revenue and profit milestones but hitting them, however, doesn’t guarantee business survival. Cash flow is that barometer.
A profitable business doesn’t mean a cash rich business. Why? Because of something that accountants call “timing difference”. Simply stated this is the difference between the date of a transaction (sale or purchase) and the date when cash exchanges hands.
Income Statements (P&L) don’t take into consideration “timing”. Their purpose – beyond determining corporate taxes – is to allow you to see if sales and the total expenses associated with them are following the expected trajectory, so that’s an operational report card. A Cash Statement (the Cash Flow Projection report card), on the other hand, factors in “timing” so it provides both a pulse on the health of the entity and a flag warning of any potential rough patches.
Picture this your business is a marathon runner. Thus, making your revenue and profit objectives would equate to hitting the planned mile split times during the race, while the latter – cash statement – would be the monitoring of the heart rate and hydration level. If these vitals are not held at a safe level performance in the short run might be maintained but eventually it would deteriorate and if left unchecked a catastrophic failure will more than likely occur.
Show Me the (Cash) Money
Understanding the difference between profit and cash is a foundational concept. It makes apparent windows of opportunity to ask insightful analytic-based questions and make smart decisions. So how do you manage cash? Before proceeding, you need to keep in mind that proper cash management doesn’t mean that you have lots of cash on hand all the time. The goal is to have the proper amount of cash when needed to pay off everything that’s due at that moment.
Here are five basic cash management steps:
- Understand your needs.
- Collect the right data. The key to developing a good cash flow projection is to gather historical information on the amounts and timing of cash movements (sources and uses) by compiling contractual obligations, converting sales forecasts, and determining market norms for payment terms.
- Analyze your situation. Develop a realistic projection of the timing and amount of your of your inflows and outflows.
- Perform a service-by-service analysis. Use you new insights to determine which items are profitable and contribute to cash. Getting the mix right is important for your success.
- Rinse and repeat. Just like a weather forecast at any given point in time all you have done is quantify a cone of certainty. As time marches on you will gain more data, external tastes will sway, and the competitive situation will evolve. At a regular interval take this new information and update your projections, map it to your strategic expectations, and practice focused execution.
The ultimate lesson… a healthy business needs both profit and cash.
“Timing Difference Drivers”
- Revenue is booked at sale. The sale amount is recorded whenever the product or service is delivered, regardless of when cash is/was collected.
- Expenses are matched to revenue. All costs associated with generating revenue during a period are recorded with the sale regardless of when cash was/will be paid.
- Capital Expenditures (Capex) doesn’t count against profit. Cash expenditures for business assets (trucks, furniture, etc.) are fed into income statements over a multi-year period via depreciation.