Cash is King…
I had the chance to talk with one of my fellow PBCA members (Professional Business Coaches Alliance) the other day who is also a CPA. I always find it interesting to get his perspective because I (like a lot of people) sometimes get overwhelmed with financial jargon.
Unlike some CPAs, John does a great job of keeping things simple. A big part of the discussion we had was on the importance of Cash Flow relative to the health of a business.
Discussions on Income Statements and Balance sheets are often where an accountant will take you – and those are very important things to keep up to date and accurate, but they won’t always tell the whole story and they’re often more complicated due to accounting standards and can be difficult to plan with.
As an example, the downfall of Worldcom was detected because their cash flow statement didn’t match the story they were telling investors. The income and balance sheet looked okay, but obviously there was something going on. It’s possible to create profit on accounting statements, but it’s much more difficult to create more cash in the bank account.
For a typical small business, cash flow becomes the most straightforward way to gauge how you’re doing. Will I have money in the bank next month? How about the month after that? If I get a loan, will I have enough money to pay for everything and still service the loan?
Obviously a consistent trend of spending more than you make is going to cause a problem.
Cash flow is also important from a planning perspective in order to successfully manage growth. An extreme example is a building company that is selected for a major project.
From an accounting perspective, the company accounts receivable, the money they’re owed for the project is very high (pending successfully delivering as promised).
However, in order to successfully deliver the work, they need to hire large teams of people and bring on lots of equipment and supplies up front. Typically they’ll have to pay for those things well before they get paid.
The good news – you’re projecting $200,000 in profits for the year. The bad news, you need $500,000 in cash in the next 2 months in order to get that profit…and you don’t have anything in the bank. More than likely you can get a loan (especially on guaranteed work), but there are definitely limits on what you can do. If a loan is out of the question…then no cash and no future profits.
How is your business cash flow trending? It’s expected for start-up businesses to run a negative cash flow for quite a while, but there should be a reasonable plan in place that projects when you can get to break-even and beyond (see Break-even Analysis 101)
For a more mature business, if your cash flow starts to decline, you can look at tightening up your invoicing approach to encourage your customers to pay you more quickly. You can also look into delaying your payments a bit. Both approaches can give you extra liquidity / cash in hand, which gives you a lot of flexibility and peace of mind.
Shawn Kinkade www.aspirekc.com