There is a big misconception in business. That is the most important number to pay attention to is your profit number.
I disagree. I think the most important number to watch is how much cash you have on hand and whether the amount of cash is growing or getting smaller.My biggest mistake in my early business days.
I had my own business when I was 24 years old. The first year or two was stupendous. The business was growing, my profits were great and life seemed to be wonderful.
Then one day I walked into my office and there were several messages from vendors. They wanted to know when they were going to get paid.
We were supposedly making plenty of money and if you read our profit and loss statement that’s exactly what they said. At the same time, we didn’t have enough cash to pay our bills. I wondered how this could possibly happen.
The issue was I didn’t understand how making a profit and having positive cash flow don’t necessarily go together.
You see accounting rules don’t really serve small businesses. They’re designed for big businesses. And I certainly wasn’t a big business.
I didn’t realize that all of the equipment I was buying didn’t show up as an expense on my profit and loss statement. It did show up on my cash flow statement and had I known how to read a cash flow statement I would have known I had a potential problem brewing.
Profits are nice, but cash is better.
I loved seeing profits in my P&L. I thought that a growing top line and growing profits was where it was at.
This was my first, but certainly not the last hard lesson I learned in business. I learned that having cash available was king. Without cash I couldn’t play the game very well. Instead of focusing on making my company better I had to spend too much time juggling cash trying to keep my vendors off my back.
I quickly learned that large public companies were the ones that needed to pay attention to profits. For public companies profits drives their stock price. I didn’t care about the price of my stock, I needed to care about how much cash I had in the bank.
This is something you also need to pay attention to. Without enough cash you can’t fund your retirement, you won’t have money for a rainy day fund and you won’t have money to fund growth.
Don’t get caught up in only focusing on profits. Make sure you focus on cash as well.
How is a cash flow statement put together?
This is where life gets a little complicated. A cash flow statement is not something that stands on its own. A cash flow statement is a combination of the changes in your balance sheet as well as key numbers from your profit and loss statement.
Your profits are a source of cash. So is depreciation and any loans you might get from a back. A use of cash is an increase in inventory, accounts receivable or equipment you purchase. Some of these numbers come from a comparative period in your balance sheet and some from your profit and loss statement.
What’s so important about a cash flow statement?
When I start working with a business, the very first financial information I want to look at is the cash flow statement. I want you to do the same.
A quick look at your cash flow statement can tell you whether you’re going to have a hard time funding business operations. It can tell you whether you’re going to have a cash problem in the near future or even if you’re in a full blown cash emergency like I was.
The problem I see way too often is there are very few business owners that either understand or read their cash flow statement a regular basis. If they did, there would be way more businesses who had healthy cash positions.
Who can help you understand your cash?
This short blog post isn’t meant as a primer on how to read or prepare a cash flow statement. If you don’t look at your cash flow statement and or don’t understand your cash flow statement I want you to find someone who does and can explain it to you.
This person might be your accountant, it might be your controller or CFO. It could be a CFO for hire or you could decide you want to have a conversation with me. One of the first thing I do is make sure those who I work with understand how a cash flow statement works and how to get useful information from it.
So, what do you think? Are you willing to do what it takes to learn how to read and use a cash flow statement in your business? Why don’t you click here and let me know how you’re going to do this?
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