VenturePORT Series - Cash Flow Equals Profits!
Over the years I have interviewed thousands of business owners looking for financing. The vast majority of business owners were very good technicians going about their business.
However, many of them would struggle to understand their finances. Even if they could afford to hire a reliable financial person to manage the accounting function, the owner often struggled to understand why "my financial statements indicate I am making a profit but where is the cash?" You know you make a profit every month, but you don't know where your cash is.
Every successful business owner understands a business needs to stand on two legs: the cash flow management leg and the profit management leg. These two legs are equally important to the business. There must always be a strategic balance between these two processes. Ignore one of them and you risk losing your business.
It is important to understand the difference between cash flow and profit. Remember the saying, "Cash is king?" Well, it is. Positive cash flow will produce profits. Profits don't always produce positive cash flow.
When motivated business owners take the time to really dig into and understand their business cash cycles and their break even points, they gain a much better appreciation for the impact of their daily business decisions on the cash flow of their business. The sooner they do this, the sooner they achieve positive cash flow.
How does a business owner go about gaining a better understanding of their cash flow? Well, those who accomplish this will share that it takes a lot of effort. Many folks admit pain motivated them to understand their finances. They prepare a month-by-month cash flow budget for the next fiscal year. As they build it, they record written, supporting assumptions explaining why the budgeted numbers are what they are.
The written assumptions are the most important part of any budget. They represent the reasoning behind the numbers. Written assumptions demonstrate the business owner has a clear understanding of the business cash cycles. These written assumptions are invaluable when discussing your company performance and financial needs with your lender.
Yes, it takes time and a lot of effort to build an accurate and realistic budget. It cannot be "downloaded" from the accounting system. It cannot be "hired out" to a consultant. Accurate and realistic cash flow budgets require a lot of effort. Remember what your folks used to tell you? You get out of it what you put into it.
Meaningful break-even data must also support the cash flow budget. It is vital to know what the costs of production really are in any business. Knowing these costs will drive the business owner to prepare competitive pricing and improve cash flow.
As you know, most successful companies accomplish strong cash flows by controlling costs, not by raising prices. Competition is a ruthless taskmaster. If your prices are too high, the customer will go elsewhere to find the product or service. And pricing will often indicate the volume of units sold to generate the sales to create the cash flow to support the business.
Essentially, break even is managing the pricing, volume and cash flow (profit) of a business. This information leads business owners to make more informed decisions when it comes to expansions, increasing production, closing a plant, adding a machine, hiring staff, or hundreds of other decisions made each day.
Some believe profit management (break-even) is more important than managing cash flow, and reason if there are no profits, there will be no cash flow. This is faulty reasoning. Remember, positive cash flow will generate profits. Many profitable businesses failed because they ran out of cash.
Once the cash flow budget is built, measure its performance by examining the monthly and year-to-date variances between the "budgeted" and "actual" performances. By doing this every month the business owner will begin to understand what is happening with the cash flow of the business. Constantly comparing the "actual" to the "budget" should inspire the business owner.
Before it is too late, begin the process of budgeting and managing the cash flow of your business. Rather than chasing the cash, the business owner begins to make daily business decisions with a new, strategic perspective.
Instead of asking how each decision will impact the profits of the business, owners will ask, "how will this decision impact my cash flow?" And you will sleep better at night.
Tony Busch is president of Priora Cash Flow Management, LLC.
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