By Brittany Lorenzi & Carson Fears
How is your business doing? If you’re like many small business owners, you might think good sales means good business. “Sales are good, so we must be profitable.” But when cash shortages appear at the end of each period, you might begin to ask yourself, “What’s going on here?”
The truth is, revenue isn’t such a good metric for determining your venture’s success. That’s because it doesn’t factor in expenses, which are sure to be high for a growing company. Subtract those out and you’re left with profit. Sure, that’s a useful number; ultimately net profit does tell how much you make. But it doesn’t tell the whole story!
Enter cash flow forecasting, a practical concept to avoid going broke. Cash flow tracks money in and out. It’s transparent accounting - nothing can hide. Cash flow forecasting is indispensable, and here’s why:
Profit and Cash Flow Differ:
Financial reports that show profit will actually include non-cash transactions like depreciation. They also show purchases of new assets spread out over time. For accounting purposes, only a portion of the expense is recorded in a given period. The trouble is, in reality these expenses are incurred all at once. It isn’t difficult to see where a cash shortage might arise.
Growing a business under cash restraints can be a major headache, but the solution is simple: maintain plenty of working capital.
Working capital is defined as current assets minus current liabilities (i.e. what you have now minus what you owe soon). In practice, however, it usually just means the cash you have on hand. Working capital is a buffer to pay the costs of sales (inventory, labor, etc.) until cash is actually received.
The trick is, once cash is received, a portion of it must always be held on to. That way you have working capital for the next inventory purchase, payroll expense, etc. Think of it as a cycle: cash to sales, sales to cash, repeat.
Working capital shortages can bring business to a halt, jeopardizing customer relationships and your bottom line. But responsible cash management and a firm understanding of the difference between revenue, profit, and cash flow can mitigate the risk of going broke.
Bankrupt businesses sometimes have good revenue. Escape the pitfalls of sales induced over confidence and regain control of your venture today. Pay attention to cash flow. Create a log of every cash transaction, or use a cash flow template to forecast spending. Be diligent, and remember the value of working capital. It’s your buffer, your lifeline to making sales. Responsible cash management is a sure path towards sustained growth.
Do you want to gain a better understanding of your business? Your personal CashFlow Story © will give you a snapshot of your cash position. Contact Brittany Lorenzi at email@example.com to obtain your CashFlow Story © today.