Why are you in business? Some people say they are in business to deliver a certain product or provide a unique or special service. Others might say they are developing a breakthrough technology, or are out to deliver the highest level of quality.
Although these are all very important aspects of running a successful business, they are NOT the reason you are in business. A company is in business to make a profit. There is no higher priority, period.
Certainly many factors, including quality, customer service, or providing a useful product or service, contribute to the profitability of any company. But profit is your prime directive. And when it comes to making and sustaining profits, cash flow is critical. Here’s why:
Profit without cash conversion is meaningless. If you don’t manage your resources, you will outstrip your cash faster than you can earn it and put yourself out of business.
This is not just a problem for companies that are struggling financially. It can also happen when a business is growing quickly and invests too much money inefficiently in scaling. In either case, improper forecasting is to blame. Too often companies do not pay enough attention to controlling costs until they run out of cash. By then it’s too late to take the actions necessary to avoid a crisis.
However if you know when a cash crunch is looming, you can manage it before it materializes. The only sure way of doing this is to estimate your company’s future performance – profit – and the cash generated and required by that performance. Your most important tool in this effort is a forecast.
A forecast is not the same as a static budget. It is a changing set of numbers that you constantly update as conditions develop. It can be as simple as writing an estimate of revenue with the expenses you expect to incur while generating and supporting that revenue. As long as it gives you an idea about what the target is, and what it will take to get there, you will have something to compare with your actual performance each month.
When you compare your company’s actual performance to your forecast, you can determine what actions you need to take to stay on or get back on track. This may mean reducing expenses (payroll, travel, etc.), cutting back or delay capital expenditures (equipment, etc.) or borrowing funds to get through the shortage.
Converting profit into cash in the shortest possible time should be your goal. Keep these three principles in mind:
Principle 1: Cash is the Lifeblood of Your Business. Cash and profit are not interchangeable. Since companies can’t actually “spend” profits, they must have sufficient cash available to fund operations until conversion occurs. Since there is nothing tangible returned by profit alone, there is no REAL profit without cash conversion.
Principle 2: Generating cash is the most important aspect of profit management. Cash is required to purchase everything your business needs, and it has to come from somewhere – either operations or outside funding.
Principle 3: Profitability and cash flow are inextricably linked. You must have profits to produce cash and you must have cash to produce profits. The cycle cannot be broken indefinitely without seriously negative results.
It takes disciplined planning to avoid or manage your way through a cash shortfall. Your ability to run your business by the appropriate numbers is crucial to your success.
Over time, as you continue to make comparisons, you can refine your forecast to incorporate a much higher level of detail. Soon you will have a very sophisticated and useful tool to guide you on your path to success.
About the Author: Fred Parrish is Founder and Chief Executive Officer of The Profit Experts™., an affordable CFO service that helps small business owners improve their profitability and cash flow. He is also creator of The Profit Beacon™, a new app that provides predictive analytics to help businesses make smart and timely decisions, and author of “The Profit Mentality.” During a 37-year career, Fred has held positions from staff accountant to CEO in public and private companies with revenues ranging from startup to $3.5 billion. He’s served on the boards of directors for 12 organizations in aerospace, manufacturing, healthcare services, insurance, international missions, technology and other sectors. Small businesses from restaurants to plumbers to manufacturers have survived and thrived with expertise from Fred and The Profit Experts. He is co-writing a book with Michael E. Gerber, author of the E-Myth series, known as the World’s #1 Small Business Guru. For more information please visit https://theprofitbeacon.com.