So, yeah, there are people who manage their entire business based on their bank balance. But when they’re smart, they also know what’s coming out of that bank and what’s going in.

ACCOUNTING PROFIT VS CASH FLOW

When one looks at an accounting set of financial statements, it doesn’t tell you whether or not your cash rich or cash poor. What really tells you whether or not your cash rich or cash poor in an organization is that weekly check in, or that by weekly or monthly check in on your cash flow that says, where are we today and where is our cash going to be? And that is super important. I’ve seen profitable organizations run out of cash.

The 2 or 3 things that will drive a company into cash flow issues despite being profitable? One is collection on their receivables. You know, you have clients who pay you in 30, 60, 90, 120 days where you recognize the revenue when you do the sale.  Oftentimes you have clients who give you cash, deposits ahead of a transaction. One would think, oh, well, that’s great, I get the cash in advance. But then what you have to always remember is I’m going to have to eventually incur the expenses that go with that cash that I got. And so the mistake that in that organization is they recognize the revenue on those deposits when they received it, but they didn’t set up the costs. And so the timing of when those costs are incurred versus when that cash comes in, there’s a significant gap. Well, if you haven’t done a cash flow to time your cash, you may spend that money on something else when it comes time to pay it.

The other thing is inventory. You know, if you’re selling products, you have to invest in inventory ahead of a sale. So when you buy that inventory, you’ve got to make sure you’re choosing that inventory effectively so they can cycle through, you know. So we look at the different cycles, the inventory cycle, the cash receipts, the sales and cash receipts cycle, and the purchases and disbursement cycle when building a cash flow, because awareness of those different cycles and how they interface with profit versus cash flow is really important for entrepreneurs.

Look at your receivable balances, look at your inventory balances and look at your accounts payable balances. And be aware of your normal fixed operating expenses and put those together on a sheet and see what’s coming in and what’s going out.

BUILDING A CASH FLOW: THE INPUTS

You know, there are some standard inputs that are critical to getting a good cash flow forecast. One is your cash transactions through your bank, one is your predicted sales, one is your predicted collections on your existing accounts receivable, which are the balances that your clients owe you. How is that going to come into the organization? And then there’s your accounts payable.

How are those accounts payable going to flow out to the vendors thinking about good vendor relationships, thinking about the organization’s needs and your credit limits, and a number of other things. And there are your operating expenses, which are the normal operating expenses, things such as salaries, things such as your principal and interest payments on your loans, things such as the repayment of IOUs that you’ve reached into to the shareholders, and so on.

And so, you know, you have to get the inputs to get a proper cash flow. I’ve seen a lot of organizations that look at cash flow in a very simplistic way, and can’t understand why the cash didn’t end up where they thought it would.

WHAT MAKES A GOOD CASH FLOW REPORT?

So the typical cash flow report should go, I typically say 4 to 8 weeks back and 8 to 13 weeks forward. And the reason why you want to do that is that if when you’re doing that assessment, you see that there might be bumps in the road or there might be challenges, you can plan for that.

You can often engage in conversations with your bankers, for example, to say, hey, you know, we might have a bump there, or you might see a permanent issue where you might say, we need to increase our credit line. Is that a possibility? So the cash flow cycle looking ahead allows you to have that discussion far enough in advance that you can find alternatives.

FINAL THOUGHTS

Failure to consider cash flow has resulted in bank intervention more times than I care to count in my career. You’ve had companies where the executives say, I don’t get it. We’re profitable. And I say, but your ability to predict your cash has your stakeholders concerned.

So my best advice I could give to any entrepreneur,  you better have some method of knowing where your cash is going to because cash flow is the ultimate. You know, you’ve heard that statement, cash is king. Okay. And so the importance of a cash flow boils right down to that statement. No matter how profitable you are, cash is king.