Cash Is King
We Haz Cash? Your business has to generate more cash than it uses if you’re going to survive. That sounds too obvious; that’s what profitability is all about, right? Right. But what a lot of people don’t understand is that you can’t spend profits unless they’re cash profits. Paper profits aren’t worth the paper they’re printed on when it comes to survival and growth.
In this chapter of the Finding Money ebook we look first at some common misunderstandings about financial statements and what cash flow is and isn’t. We cover the essentials, so you’ll know how to figure how much money you need to find. It may sound like high-finance but we explain in clear terms why Cash Flow Isn’t Profit—and vice versa, the basic concepts behind Cost of Goods Sold, Operating Expense, Depreciation, Interest Expense, and why Cash Flow Isn’t Net Worth, Cash Flow Isn’t Working Capital.
Sfx: Twilight Zone theme music. Consider, if you will, fictitious Surgical Products Company, a highly profitable manufacturer of post-operative medical supplies for home use. During start-up they hired people, purchased manufacturing equipment and raw materials, ran the machinery to produce their introductory products, and then paid a sales team to sell them. Their salespeople, it turned out, were very successful at generating orders at prices that offered a good profit.
They sold $2,000 in Month 1, $5,000 in Month 2, $10,000 in Month 3, and sales continue to grow by $5,000 a month. Their cost of production is only 45% of sales, which leaves a healthy gross profit margin of 55%– more than enough to cover operating expenses and still produce a profit.
Sounds great, right? Wrong. Some time this month they’ll collect part of the money customers owe them from last month. The balance of their receivables will be collected in sixty or ninety days. Meanwhile, they’re working overtime to fill this month’s orders. They’re paying for the extra supplies they ordered last month in anticipation of continued growth, plus they’re ordering more supplies for next month’s sales, hiring more people, expanding their facility, etc. With any luck, the sales trend will continue and they’ll do it all over again, but bigger next month, the month after, and so on. That is, as long as their cash flow holds up.
As it turns out Surgical Products Company, in spite of the success, is actually in real danger of going, make that growing, broke! Even with thirty day terms from their suppliers this successful manufacturer is in the red by the end of Month 6. And, by the way, those numbers don’t include any other operating expenses—little things like rent, telephone, office supplies, and payroll, not to mention groceries for the owner. The fact is they can forget those extra people and expansion plans. They don’t even have the cash flow to support what their doing now.
Want to know how to keep that from happening to you? We look at several scenarios and solutions in the Finding Money ebook.
