The Essence of Strategy // The Essence of Profitability // The Essence of Marketing // The Essence of Funding // The Essence of Cash flow
Five by Five – Module 5
THE ESSENCE OF CASH FLOW
“It had been another long week for Mike. As he drove home that Friday night, he reflected on why, from the beginning, things never seemed quite right.
He thought about how exciting the idea was to have his own
business. He could be his own boss and have the freedom he’d
always longed for. Even if he only made half the sales he thought were possible, he would be so far ahead financially; there hardly seemed any risk at all. And with the profits he would make, they would be far better off financially.
But things had not quite gone the way he’d thought they would. Every month there seemed to be more money going out than coming in. It wasn’t just the wages bill, but also the fact that he had to buy stock to sell next month and pay rent and outgoings. He dreaded each quarter when his accountant would tell him the amounts to pay for his quarterly tax payments; and at the end of the day, even though he owned the business, he seemed to always be the last person to get paid.”
(Excerpt from “Where’s the Money Gone” by Andee V Sellman)
He thought about how exciting the idea was to have his own
business. He could be his own boss and have the freedom he’d
always longed for. Even if he only made half the sales he thought were possible, he would be so far ahead financially; there hardly seemed any risk at all. And with the profits he would make, they would be far better off financially.
But things had not quite gone the way he’d thought they would. Every month there seemed to be more money going out than coming in. It wasn’t just the wages bill, but also the fact that he had to buy stock to sell next month and pay rent and outgoings. He dreaded each quarter when his accountant would tell him the amounts to pay for his quarterly tax payments; and at the end of the day, even though he owned the business, he seemed to always be the last person to get paid.”
(Excerpt from “Where’s the Money Gone” by Andee V Sellman)
Does this sound familiar?
Cash flow is the single biggest reason why businesses fail. Without the correct reporting mechanisms, you can easily find your cash flow is out of control. Many business owners spend their life with their accountant’s reports in one hand and a bank statement in the other trying to work out what is happening while asking, “Where’s the money gone?”
Have you heard the phrase ‘cash is king’? Well, whoever coined it is absolutely right! Inadequate cash flow is the single biggest impediment to a business functioning efficiently because cash flow is the lubricant that oils the business machine.
Have you heard the phrase ‘cash is king’? Well, whoever coined it is absolutely right! Inadequate cash flow is the single biggest impediment to a business functioning efficiently because cash flow is the lubricant that oils the business machine.
Why then is this often so difficult to understand for a business owner?
Often it is because people intuitively think profit is the same as cash. They have never had it properly explained to them why and how this is NOT the case in 99% of business situations. Compounding this is the fact that most business reporting does not give a clear overall picture of the business. Most reports only show one part of the business at a time. They don’t give the whole picture in context, linking operational actions to their financial outcomes.
The Financial Fence® lets business owners get the complete financial picture. A greater understanding comes as you see the Balance Sheet, Profit and Loss Account, and Cash Flow Statement, assembled on a single page. The Financial Fence® also helps you understand the difference between profit and cash flow. Again, using a visual format, you can see an overview on a single page.
This proven tool gives business owners the ability to drive their businesses with confidence and ease.
The essence of The Financial Fence® can be seen in the diagram below which shows that profit and cash flow are different but still related.
The Financial Fence® lets business owners get the complete financial picture. A greater understanding comes as you see the Balance Sheet, Profit and Loss Account, and Cash Flow Statement, assembled on a single page. The Financial Fence® also helps you understand the difference between profit and cash flow. Again, using a visual format, you can see an overview on a single page.
This proven tool gives business owners the ability to drive their businesses with confidence and ease.
The essence of The Financial Fence® can be seen in the diagram below which shows that profit and cash flow are different but still related.
The overriding frustration we have heard from business owners is that they have no framework through which to view their business as a complete picture. As a result, the financial side of the business is run separately to the operations, leading to mixed results on implementing the vision and strategy for the business.
Understanding that profit and cash are different allows you to plan more effectively. Ever heard the phrase, “You can’t go broke making a profit?” Well, that is NOT always true. If you have a friendly banker who keeps lending the money to pay for the capital you are accumulating in your business, you can keep trading and hopefully make a profit. However, if the banker says, “No” to more funding, you will stop trading as soon as the money runs out. In growing businesses, whether or not you are making a profit, without adequate planning and control, you will run out of cash! This is because growing businesses need more and more cash to pay for their increasing investments in capital.
Controlling cash flow requires an appreciation of how capital flows into the business. Much of the capital growth in a business is not the result of one big decision; it is the accumulation of many small, seemingly unimportant, decisions.
Here’s a good question for you to consider. What is more important in a transaction, the terms or the price? While both are important they affect a different part on The Financial Fence® and therefore a different part of your business. How will terms affect you? Let’s consider two types of customers. The first requires you to give them 60-day terms, while the second customer requires only 30-day terms. How would this affect you?
Obviously you would be waiting longer in the first example to receive payment. So how does this affect cash flow? To work this out you have to ask yourself another question. “Where is the money hiding in my books?” When you make a sale you can record it in your books to calculate whether or not you made a profit. But where does the money hide? In this instance the cash is still tied up in Accounts Receivable. When you look at where it appears on The Financial Fence® you’ll see it recorded as capital. So the longer it takes to get paid, the higher the capital will grow.
Understanding that profit and cash are different allows you to plan more effectively. Ever heard the phrase, “You can’t go broke making a profit?” Well, that is NOT always true. If you have a friendly banker who keeps lending the money to pay for the capital you are accumulating in your business, you can keep trading and hopefully make a profit. However, if the banker says, “No” to more funding, you will stop trading as soon as the money runs out. In growing businesses, whether or not you are making a profit, without adequate planning and control, you will run out of cash! This is because growing businesses need more and more cash to pay for their increasing investments in capital.
Controlling cash flow requires an appreciation of how capital flows into the business. Much of the capital growth in a business is not the result of one big decision; it is the accumulation of many small, seemingly unimportant, decisions.
Here’s a good question for you to consider. What is more important in a transaction, the terms or the price? While both are important they affect a different part on The Financial Fence® and therefore a different part of your business. How will terms affect you? Let’s consider two types of customers. The first requires you to give them 60-day terms, while the second customer requires only 30-day terms. How would this affect you?
Obviously you would be waiting longer in the first example to receive payment. So how does this affect cash flow? To work this out you have to ask yourself another question. “Where is the money hiding in my books?” When you make a sale you can record it in your books to calculate whether or not you made a profit. But where does the money hide? In this instance the cash is still tied up in Accounts Receivable. When you look at where it appears on The Financial Fence® you’ll see it recorded as capital. So the longer it takes to get paid, the higher the capital will grow.
How will price affect you?
Obviously a lower price means lower sales income per unit sold and therefore lower profits on the top rail of The Financial Fence®. So price will affect your profit, which in turn affects your cash flow, but the impact is not as severe as the impact of having to wait the extra 30 days to get paid.
Clearly cash flow is more than simply making a profit. It is affected by any investment in business capital. Therefore, to understand the cash flow of your business, you need to be able to view your whole business in one place, at one time. Without this ability, you can be left with lots of information and no context within which to understand it.
The Financial Fence® brings that context to your whole business so that you can clearly know the following three points about your finances.
1. Where you are now.
2. Where you want to be in the future.
3. A plan that clearly shows both the profit AND cash flow required to get you to your destination.
Managing cash flow in your business is arguably one of the most crucial skills required to ensure business survival. To manage it effectively you need a system gives you clarity on the impact that each decision will have on your cash flow, both in the short and long term.
The essence of managing cash flow in business is for the owner to understand that profit does NOT equal cash.
They must also, comprehend the impact of decisions on cash flow BEFORE they are made is vital for business success.
Some decisions drive cash flow into your business and others drive cash flow out of it.
The key is in knowing the difference.
Clearly cash flow is more than simply making a profit. It is affected by any investment in business capital. Therefore, to understand the cash flow of your business, you need to be able to view your whole business in one place, at one time. Without this ability, you can be left with lots of information and no context within which to understand it.
The Financial Fence® brings that context to your whole business so that you can clearly know the following three points about your finances.
1. Where you are now.
2. Where you want to be in the future.
3. A plan that clearly shows both the profit AND cash flow required to get you to your destination.
Managing cash flow in your business is arguably one of the most crucial skills required to ensure business survival. To manage it effectively you need a system gives you clarity on the impact that each decision will have on your cash flow, both in the short and long term.
The essence of managing cash flow in business is for the owner to understand that profit does NOT equal cash.
They must also, comprehend the impact of decisions on cash flow BEFORE they are made is vital for business success.
Some decisions drive cash flow into your business and others drive cash flow out of it.
The key is in knowing the difference.