by Brandon Reiter
There are three main financial reports that detail the performance of a business: the profit & loss statement (PNL), the balance sheet, and the statement of cash flows. While the PNL and the balance sheet often get the most attention, it is the statement of cash flows that is often overlooked, yet it provides the most accurate depiction of a business’ health.
Let’s take a step back and think about the typical life span of a human being. Instinctually, we are programmed to grow and reproduce. Ideally, you are born, you grow, you live, you procreate, you get old, and then of course you peacefully die in your sleep with your loved ones by your side. Those loved ones tend to be the offspring that you procreated who are, themselves, following along the same type of path as you: they were born, they grow, and they procreate. Of course, the more offspring there are, the more life spans there are, and the more life spans there are, the more procreation occurs. The more procreation, the more people.
The life span of a dollar entering your business is not so difference than that of your own. Ideally, when a dollar comes in it helps the business grow, procreates more dollars, and then dies peacefully (ideally, by leaving the business for your wallet). The more dollars reaching the point in the life span of procreation means the more life spans of dollars flowing into your business. Successful businesses optimize cash flow, so that their dollars keep on procreating more dollars, which in turn, keeps the cycle… cycling.
But how do you keep a cash flow cycle… cycling? Think of your business like a car and the cash flow as the wheels. The faster the wheels turn, the farther you go. Of course, there are plenty of components in getting a wheel to spin, keeping it spinning, and maintaining the car as a whole. To start spinning, a wheel needs inertia, to keep spinning a wheel needs grease, and to stay spinning the car needs to be operational.
To get your car started and the wheels spinning, every business needs a jump start to kick off the inertia that sets it in motion. Whether it’s an investment, a viral marketing campaign, or an exclusive patent, in order to start strong, initial inertia needs to be created. Once the wheels are in motion you can focus on the next, and most important part: keeping them spinning.
Greasing the wheel
To keep your wheels spinning and the car moving, you need to apply grease. Grease can come in many forms in a business sense; it can be more capital, endorsements, advertising, branding, and you get the point. Without any grease, the wheel will rust and be unable to keep going, leading the car to a grinding to a halt.
Be careful! Too much grease is not good for a wheel either. If you spend all your money on grease, there’s nothing else for the rest of the car and the whole thing will break down. Also I’m no mechanic put I’m pretty sure too much grease leads to other complications as well.
Every car needs to be consistently serviced if you want to drive it for a while. Just because you applied some grease to the wheels, doesn’t mean they will keep going forever. If you stop advertising, stop promoting, innovating, delegating, reevaluating, etc. your service light might go on, but it could be too late.
Creating and Maintaining Healthy Cash Flow
Getting your car started is the easy part, but keeping it going is what takes some brain power and constant assessment. In order for you to be able to do this, you must have a great understanding of your cash flow cycle and how to analyze your statement of cash flows.
A statement of cash flow gives a report of the money coming in and out of a business over a specific period of time. It has four main elements: beginning balance, money in, money out, and the ending balance.
The money coming in can be in the form of investments, loans, grants, and revenue, while the money going out can be expenses, capital expenditures, and distributions. If the money going out is consistently more than what’s coming in, the business will veer off the side of the road and smash into a tree. Better hope you have a good insurance policy (we’ll get into that later).
Notice how I didn’t simply say it is solely based on revenue and expenses? There are all of these other components, which is why simply looking at a profit and loss statement doesn’t give you the full picture of you business’ financial health. To grease it up, you need to have expenses and, in most cases, capital expenditures. To pay your rent, you need to take distributions. To maintain the car, you also need those three things. The key is not to stop money from going out, but to keep it at a rate that won’t jeopardize the ability to keep the wheels moving. In other words, keeping the money coming in.
Use your Cash flow history to forecast and avoid mistakes.
If you drive your car down the same road everyday, and you know there’s a pothole at a specific point, you would probably try to avoid the pothole. Right? Right?! Your business drives down many familiar roads each year. Therefore, using past information will help you avoid upcoming potholes.
For instance, if you know that you spend a majority of your expenses during the summer, you would want to make sure your wheels are greased and ready for the trip. Taking out a huge distribution, or spending on a massive capital project would be something to avoid right before you hit a bulk of your predicable expenses, and vice versa. If you know that the majority of your sales come during the winter, and you don’t have too many big expenses on the horizon, that would be the ideal time to take that distribution, or invest in that capital project.
While all of this may seem obvious, the point here is to stress the importance of your business’ cash flow. To keep the wheels turning, you need to keep them greased and the car maintained. And to limit the grease and maintenance you need, understanding your route can ensure a healthy drive.
To understand your route, you need to be able to forecast your cash flow and identify which are the rough roads and which are the freshly paved ones. This requires reliable data, and in order to have reliable data, you need to keep a record of every transaction consistently. If you don’t keep proper records in a consistent manner that makes sense for you, you’re basically getting into your car without a seatbelt and driving with your eyes closed.
So the ultimate question: How are you supposed to maintain consistent records, while also focusing on the road (running your business)?
The answer: Contact us.