Cash is to a business what gasoline is for a car. When there is none left, both cease to operate. Unlike the car however, you cannot just pump cash and get going again. A business on an empty tank collapses like a house of cards. It crumbles on itself unable to carry the burdens of its debts. Once it falls it’s very difficult to rebuild it. Now that cash is becoming scarce everywhere, it’s essential for you to understand your business’ numbers and monitor the “vital signs” that will enable you to make timely decisions.
You may have a profitable business and still go bankrupt. It happens continually. Profit is the result of an equation- what’s left over after subtracting expenses from your sales. In real life, you can continue to operate a business only if you have money to spend. This means having sufficient reserves to meet your financial obligations such as payroll and accounts payable. How many times have you’ve seen profitable ventures going out of business? When payment was due, the business had no money in the bank. Suppliers ceased to supply and there was nothing to sell to generate more revenues.
Cash flow has a lot to do with timing; having the money when you need it. That is what the Statement of Cash Flows is all about. Unless you learn to read financial reports, it will be difficult for you to follow the money in your business. A cash flow statement is like a checking account ledger on steroids. It demonstrates and explains the net increase or decrease in cash and the balance at the end of a period. Most accounting software includes such a report plus there are plenty of spreadsheets in the internet that you can download for free.
Another critical report is the Income Statement, also known as a profit and loss statement. It registers the profit or loss of a business based on its sales and expenses at any one given period of time. This report also helps you create a budget for the future. By examining your past operations you can prepare a list of your projected revenues and expenses. This is relatively simple. You begin identifying a typical monthly revenue stream (how much you are selling and where is it coming from). Then you go individually over each of the twelve months; to consider account variations based on seasonal or particular expectations. You repeat the process for expenses. By subtracting expenses from the revenues your budget will have a profit or loss.
Of course all the software and tools will be useless if you don’t use them. Sure it’s more entertaining to focus on other aspects of your business but it’s a tradeoff and it’s your choice. Do you want to be proactive and anticipate potential issues or experience the shock of a crippled business unable to meet its financial obligations.
Keeping your books is not just for tax purposes. Cease relying on accountants and financial advisors to tell you what you need to know (especially if it’s about events that already happened and cannot do much about it). Instead get them to teach you how to read your balance sheet, profit & loss statement and statement of cash flows; or read and learn; there are plenty of books out there.
Think of how hospitals take care of patients in their intensive care units. Nurses place sensors all over the patient and monitor the signs so they can anticipate and make timely interventions. It’s the same principle in business.
I am not suggesting you to become an accountant or skilled in mathematics. A nurse is not a doctor and it’s still the person who looks out for the patient. I do recommend that you become aware of the importance of keeping score of your numbers; that you understand them and take early action.
By spending time learning how to read a few financial statements you will acquire critical skills to strengthen your business. You will be ready to interpret data necessary to make timely decisions and take early action. Is your business ready to produce adequate cash to see you through the rough times ahead?