Many entrepreneurs assume that if the price they charge for products or services is greater than what they cost, everything will be okay: they will be profitable and successful.
Profit is good – but unfortunately, it is simply not enough.
To pay your bills and provide a predictable, reliable income for yourself (so you can support your family), you must also have healthy cash flow. In fact, more businesses go bankrupt due to a lack of cash flow than any other single reason.
If you don’t understand the basics of cash flow or know how to quickly identify and unlock cash that is trapped in your business, you will find yourself between a rock and hard place each month.
On one hand, you may generate a profit.. but you’ll be left wondering why you don’t have enough cash in your bank account to pay:
· tax (based on the profit calculated by your accountant)
· loan repayments
· suppliers and
· all the other people calling you daily to collect money
On the other hand, you will have:
· a surplus of slow moving or dead stock
· work in progress (time) you cannot yet bill
· unproductive assets and
· customers that haven’t paid on time – in fact, some of them may even be 60-90 days late!
This isn’t a pleasant situation for you (or any entrepreneur) to be in – which is why it is so vital for you to:
· know and understand your cash flow position
· predict problems before they occur and
· pinpoint and unlock cash that is trapped right now in your business (animation – roll the rock to simulate unlocking cash and filling up the bank account)
Cash flow also helps to make your to-do list very focused. If you know you’ve got a cash flow problem, there’s no point wasting time on tasks that won’t fix it or put more cash in your back account today.
Right now, you earn a certain amount of profit in your business but profit isn’t something you can take to the bank and deposit. It’s just an estimate of how much your income exceeds the operating costs of your business and it’s the number your accountant and the tax department use to assess how much tax you owe.
And as a rule of thumb, if the amount of cash flow you generate over a period of time is less than your profit, you may not have enough cash in your bank account to pay your bills.
When you think of the relationship between profit and cash flow in your business, imagine this see-saw in your mind.
If your profit is $120,000 for the period and cash flow is only $70,000, the see saw ( and your business) will be unbalanced – what this means is that you won’t have enough cash to pay your rent, taxes, interest, suppliers, and wages etc. The same is also true in reverse – if your cash flow ($150,000) is far greater than your profit ($45,000), this is also a potential red flag. It may mean you are liquidating assets or taking on loans (or other debts) to create cash flow quickly and this may not be maintainable by you in the long term.
To have a successful and sustainable business, your goal is to maximize profit and generate a similar amount in cash flow. You want these two numbers to be in balance on the see saw so that you have enough cash to comfortably and safely pay your taxes, wages and other bills.
If your profit is a positive number – you now know that you should focus on increasing it (increase income, decrease variable and fixed costs) while simultaneously generating a similar amount in cash flow (collect cash quicker, pay debt slower).
If your profit is decreasing or is a negative number (-$10,000), this means:
· you first need to urgently create positive cash flow ($20,000) (liquidate assets, stretch payables, inject capital)
· to keep your business afloat long enough to come back, grow profit ($20,000) (increase income, decrease variable and fixed costs) and balance the see saw.
Cash flow provides important insights which are vital to your growth and survival and it also highlights your priorities each day as a manager and leader. If you can master balancing the see saw of profit and cash flow – by maximizing profit and knowing what to do to unlock cash that is trapped quickly and easily, your success is inevitable.