The Biggest (and Most Misleading) Cash Flow Myth

For Business Owners Only

Part 2 of 3…  In part 1, we discussed the first 4 fundamental cash flow elements. We learned that Profit is equal to Revenue minus a variety of expenses.

And because all the expenses have been removed, it’s easy to make an assumption that is actually the biggest, most misleading, and potentially dangerous cash flow myth:

Profit equals cash flow.

As any failed profitable business can tell you, this is just not true.

Profit is simply a measure of operational effectiveness. It tells us how much cash our operating activities SHOULD generate, but it leaves out two critical things that can dramatically affect cash flow: timing and things that don’t affect operations. Which, if ignored, can kill the business.

The rule of thumb? Never confuse “profit” with “cash flow.”

Here’s why.

5. Timing of Receiving Revenue

Let’s get back to revenue. You’ve done some work or delivered some widgets. You’ve created an invoice and sent it to your customer. Your revenue proudly shows the total of all your invoices. Good work!

And then your customers don’t pay for one month. Or two months. Or, gulp, three months.

Can you see how the timing of customer payments significantly affects cash flow?

Your accounting system tracks how much money your customers owe you in Accounts Receivable. Which is great, but wouldn’t it be nice to know when you’re going to get paid? This is where “Accounts Receivable Days” comes in: it’s the average number of days it takes your customers to pay.

Rule of thumb: Reduce Accounts Receivable Days to improve cash flow. In other words, get paid sooner.

6. Timing of Paying Expenses

Just as your customers pay you, you pay your suppliers. And just as your customers sometimes delay paying you (which worsens your cash flow), you can delay paying your suppliers (which improves your cash flow by keeping the cash in your bank account).

Your accounting system tracks how much money your business owes in Accounts Payable. And the average time you take to pay your bills is known as “Accounts Payable Days.”

Rule of thumb: Improve cash flow by increasing Accounts Payable Days. But don’t wait too long to pay your suppliers or they may not want to have you as a customer.

7. Things That Don’t Affect Operations But Do Affect Cash Flow

Many other things affect cash flow, but keep two in mind for now:

  • loan payments, and
  • equipment purchases.

Neither of them show on your Income Statement. This makes them easier to forget when you’re thinking about cash flow. But when you forget about your $800 truck payment and the $3,500 you just spent on a new laptop, you can find yourself in a cash flow pickle at the end of the month.

Rule of thumb: Loan payments and large equipment purchases don’t show on your Income Statement but they DO affect cash flow!

Closely and Constantly

Cash is the life blood of every business. It must be monitored closely and constantly. Spend a few minutes with these 7 elements each week and you’ll develop an excellent sense of your business’s cash flow.

Tomorrow: Learn Three Common Cash Flow Mistakes (So You Can Avoid Them)

Free online Cash Flow training! Register for my November 10 session here.

7 Basic Cash Flow Elements – Part I

For Business Owners Only

Once a year I teach an entrepreneurship course at the University of Victoria. Single biggest comment from the students? “You say the word ‘cash’ too much.

Yes I do. Because 82% of businesses that fail, fail because of cash flow problems. So I’m going to keep saying it until that number drops significantly!

Here’s the first of a three part article on 7 basic cash flow elements.

The 7 Basic Elements of Cash Flow

The 7 basic elements of cash flow introduce key terms that the business owner will use throughout her career. They inform her about her cash flow and allow her to make appropriate, timely decisions. And the 7 elements naturally lead to more sophisticated financial literacy topics when the time is right.

1. Revenue or Sales

Revenue is the source of sustainable cash flow. If you create invoices for your customers, then revenue is the total of those invoices.

If you’re in a cash business, then revenue is the total cash that you receive from your customers.

Rule of thumb: Increasing revenue should increase cash flow.

2. Sales and Marketing Expenses

Sales and marketing activities create revenue. They bring appropriate customers to us and convince them to purchase.

There’s always tension in the minds of business owners about these expenses: we must spend money to find new customers and convince them to buy. But spending money reduces cash flow. So we’re always balancing the money we spend on sales and marketing with the revenue that they generate.

To reduce the tension, it’s very important to track the effectiveness of sales and marketing activities: they MUST generate significantly more revenue than they cost. How to do this is a topic for another day, but the rule of thumb is this:

Healthy cash flow needs sales and marketing activities to generate significantly more revenue than they cost.

3. Cost of Goods Sold (COGS)

When a customer buys a product from us, we incur costs related to acquiring, producing, packaging and shipping that product.

This is also true when we deliver a service to a customer: we have labor or technology costs to deliver the service.

The rule of thumb is simple: The smaller our costs of goods sold, the better our cash flow.

4. Other Expenses

In addition to sales, marketing and COGS, there are many other potential expenses that reduce cash flow: staff, rent, communications, travel, accountants and lawyers, etc.

The rule of thumb: Spend as little as you can without affecting your ability to operate effectively.

Interregnum: Profit

Everything in these 4 sections appears on the Income Statement (or Statement of Profit & Loss). Revenue is shown at the top and everything else is subtracted from it to create the “bottom line”. When our revenue is greater than all the expenses, the bottom line is a positive number called profit. When revenue is less than expenses, the bottom line is negative and is called a loss. Which leads us to The Biggest and Most Misleading Cash flow Myth

…which we’ll discuss in Part 2.

BTW, want to get some great, free online training on cash flow? Learn more about my session on November 10 here.


Good News About Business Ownership. No, Really!

For Business Owners Only

I’m researching business ownership success rates for a presentation next week. It turns out that – wait for it – the numbers are way better than they’ve ever been.

Scott Shane writes in Entrepreneur, “The rate at which American employers go under has fallen by 30 percent since 1977.”

Mr. Shane’s article then discusses five reasons why he thinks this is so:

  1. Business founders are assessing their potential startups more rigorously.
    Absolutely! We now clearly understand that startups and small businesses aren’t just smaller versions of large companies. They’re a different breed entirely. The lean approach, business model canvas, and startup events have spread this thinking everywhere.
  2. New companies are being started in sectors that have a higher chance of success. This is a predictable result of analyzing and assessing, isn’t it?
  3. Business owners are better educated than ever before. Not only do we have better models than ever before, it’s easier than ever to find good lessons and advice.
  4. The technology available to business owners is better, and it’s getting used more. I can attest to this from launching a new product last month. Creating websites, landing pages, processing orders, and setting up merchant accounts can all be done in a few hours.

These points go directly to something I’ve always preached: business ownership is a distinct vocation. And like any profession, it requires knowledge, training and practice.

Mr. Shane’s fifth point is that less companies are being started. Which means that competition to established businesses from new entrants is reduced.

This declining startup rate is often presented as bad news. But it’s predictable: business owners that are better educated and doing more up-front assessment will naturally start fewer businesses and – as we’ve just seen – fail less often.

But when they do decide to start, their success rate is higher and I bet their businesses grow faster, too.

This awareness, that “smarter = more successful”, showed up clearly in a survey of over 1,100 business owners I did last year. They identified three things they needed to be successful: better thinking, better planning, and better advice.

But – and I found this very interesting – 74.1% said that they didn’t get enough support from their professional advisors.

Hmm… seems like business owners are leading the way. Time for us business advisors to pull up our socks and catch up!

Easing The Weight

For Business Owners Only

Last week I told you about the privilege and pleasure of being the skipper of a boat during my vacation. A few days after being skipper I spent another week on a boat, but this time as crew. My friend, John Fairweather, was the skipper.

I loved it. John set the course, assigned the tasks, taught us what we didn’t know, and double-checked our work. He carried the weight of the responsibility of the boat and the crew.

Because my week as skipper and then my week as crew were so close together, I was able to feel the difference in the weight very clearly. The skipper makes the final decision, knows the answer, is calm and confident. A question is asked, and everybody waits for the skipper to answer. On a boat at sea there is no higher authority.

This weight was lifted from me with John as skipper. Even when I was doing the same chore as the previous week such as plotting a course, piloting a channel, or setting an anchor, I knew that John was there. He verified, double-checked, decided.

Of course, skippers and business owner don’t know everything and aren’t always right. There are always unknowns and uncertainty. Ultimately, though, the outcome rests on the business owner. Thus the weight.

I’m a new skipper so I’m very aware that there’s an ocean of nautical knowledge and situations of which I have no clue (or clew). Whenever I’m the skipper, John is on my speed dial. He listens, he asks, he gives thoughtful advice. I’m still the skipper, but the weight of responsibility is eased.

The same is true of business owners. I did a detailed survey of business owners last year. I asked them what critical things they felt they needed to succeed. “Trusted advisor” topped the list.

Of course it did. Who else has the experience and knowledge? Who else knows what you’re going through? Where else can you candidly share your hopes and uncertainties so that, next day, you can calmly and confidently make the decisions that your staff need you to make?

There are now more resources than ever before for business owners. Ask around and find an experienced business person you can regularly chat with. And share the weight.

It makes a big – and wonderful – difference.

The Beauty of Team

For Business Owners Only

I’m just back from an outstanding couple of weeks boating in Canada’s Pacific waters. Some awesome pics and a super fun waterfall video here.

These experiences always leave me with so much to write about – friends, food, scenery, wildlife – but I want to highlight one experience that was particularly satisfying to me as the skipper. It’s about team-building and because you’re a business owner, I know you’ll relate.

Six of us boarded our 50′ (15 metre) boat. None of my friends had any experience with a boat of this size. They had never tied a knot or set an anchor never mind charting, navigating or piloting. In fact, we started with a basic lesson on how to flush the heads (toilets).

The next lesson was on how to send out a distress call if the skipper became incapacitated. This is when they started to get nervous. They realized that they were completely dependant on the boat and me. Alissa asked, only half-jokingly, “Is it too late to change our minds about this holiday?”

Sound familiar? Sure – anybody who has grown a company has been here. Too much depending on one person. New people feeling uncertain, not knowing how to contribute. Everybody feeling a little apprehensive.

But, also, everybody feeling a sense of the potential, of the possibilities, of being at the start of something new.

It’s the skipper’s job – the business owner’s job – to take this goodwill and transform the newbies into happy, confident, contributing team members.

Which means letting go, trusting our crew, and sharing our knowledge in the best way we know. It means making mistakes, and forgiving mistakes, and allowing the natural good nature of people to surface. It’s less about what needs to get done and more about the way it gets done. With laughter, and encouragement, and fun.

Within a few days our boat had a crack anchor team that could properly set and weigh anchor. And who discovered a novel way of washing the anchor.

Our boat had an “away team” that could deploy the tender and do a stern tie (Mediterranean moor).

Several crew could manage the helm in open water or through very narrow channels.

And the galley produced meal after amazing meal, from omelettes to steaks to seafood paella. Which REALLY makes for a happy boat!

Not only is team-building the skipper’s job, it offers the greatest reward. Seeing a smile when a knot is well tied; hearing the crew take pride in a perfect docking; watching their pleasure at piloting a tight channel – these are gifts that I received from my friends this holiday.

And, from a practical perspective, a competent team leaves more time for the skipper to do other things. Like planning and charting. Oh, and fixing the aft head – yes, I was up to my elbows in a toilet bowl one day… 🙂

Yes, I’m sure it’s easier to do a little team-building on a holiday with wonderful friends. But the principles are the same for crew or staff. This was a great reminder for me (who is too often serious) of what’s really important. A reminder to enjoy the journey and share the fun as I build my professional team this year.

Thank you Alissa, Bill, Renata, Sandy and Susan for the skipper lessons and for a great week!

And if you, dear reader, ever want to holiday in a boat off Canada’s amazing west coast, drop me a line. I’d be happy to help you out.

The Pursuit of Craft

For Business Owners Only

Out for dinner last night with my friend, Bill, and we were served a pair of exquisite appetizers followed by superb meals. This prompted a discussion with the restaurant owner, Richelle Osborne, about the craft of cooking.

“Our chef, Emil, is a culinary artist,” said Richelle. “He sweats every detail of the meal, from food source to final presentation. Nobody ever meets him yet everybody loves him.”

Richelle has run Blighty’s Bistro for twenty years and, amazingly, it is still full every night. Remarkable in an industry where short life spans are the rule.

Some of its current success is certainly due to Emil’s creations, but he’s the fourth chef that Blighty’s has had. As we spoke with Richelle and her staff, the real secret to Blighty’s success became clear: Richelle is dedicated to the craft of running her business.

Yes, the food is important. But it’s her deep understanding of her customers, her staff, pricing, suppliers, consistency and cash flow that has created the environment in which Emil can flourish. By relentlessly pursuing the craft of business ownership, Richelle has created a wonderful virtuous circle. Her customers experience world-class gastronomy in their neighbourhood, and her chef has the freedom to pursue his creativity.

The majority of small businesses are started by people wanting to pursue their craft, their skill, their passion, in their own way. Richelle shows us how to do this successfully: combine the pursuit of craft with the craft of business ownership.

Yes, I am on holidays, but I couldn’t resist sharing this fabulous meal and Richelle’s story with you.

You’re The Skipper of Your Business

For Business Owners Only

I’m getting ready for my boating holiday. Friends are visiting from the Canadian prairies and we’re going cruising in Desolation Sound for a week. I can’t wait!

In the meantime, I’m charting our course, setting the waypoints, and planning the fuel and food. I enjoy doing this. I’m a planner by nature. And my future self always appreciates getting a detailed plan with turn-by-turn instructions.

I started boating a few years ago when I moved to Vancouver Island. The scenery and wildlife are stunning, and there are hundreds of islands, bays, and fjords to explore.

There are also countless dangers from tides, rocks and currents. I started learning about these from my first instructor who has the best boating name ever: John Fairweather. John has become a great friend. He’s a huge fan of trip planning and paper charts. He’s on my speed-dial whenever I’m on a boat.

My aspiration (because every boater has one!) is to visit Cape Horn at the southern tip of South America. Yes, it seems far-fetched, but it spurs me onward; every year I cruise a little further, and ever year I take a course or two. This autumn: Spanish 101 and diesel engine maintenance.

Of course, I can’t help comparing boat trips to running a business. You knew this was coming, didn’t you? 🙂 There are many similarities and one huge difference: nobody ever tells me that learning and planning aren’t needed for a boating expedition.

Yet this happens all the time in the business world. Planning is pooh-poohed. Fundamentals are ignored. People are encouraged to just “do it”, get out there, make it happen, woo hoo! Startup events all over the world provide energy, enthusiasm and encouragement. Sometimes a well-meaning agency contributes money or space.

And another group of creative, high-energy people jumps off a cliff. What a waste.

I get it. Charting is tiresome. Tide tables are boring. And plotting a course isn’t as fun as having a cold beer with the crew. But running out of fuel or hitting a rock REALLY sucks. So we do these things when we’re the skipper because we’re ultimately responsible.

Just like a business owner.

As you set out on your amazing entrepreneurial adventure be sure to carefully think through the five things below. Already under way? It’s never too late to revisit them; it’s never too late to learn something new; it’s never to late to change your course.

  1. Make sure somebody wants to buy your offering.
  2. Price properly.
  3. Learn cash flow basics.
  4. Plan, including cash flow projections.
  5. Track your progress, and adjust as necessary.

And if you need an expert on your speed-dial, call anytime.

I’m going to take three weeks off and return to my blog on August 29. In the meantime, learn more about pricing, cash flow and planning or sign up for some one-on-one coaching in September.


How to Shift From Business Founder to Business Manager

For Business Owners Only

A couple, friends of mine, own a business they started several years ago. “We’re crazy-busy, our customers love what we’re doing, and we’ve just achieved a significant milestone. But we’re overworked, stressed out, can’t get great staff, and we’re not making enough money. What are we doing wrong?”

They’re not doing anything wrong. In fact, they’ve done so many things absolutely right.

They started with a long-term vision. They’re deeply creative and have built something wonderfully unique. Their ideals and values, which are woven into their business, resonate with an international community. They are devoted to their customers; they listen acutely to their needs and suggestions and work hard to incorporate them.

But my friends are exhausted, not exhilarated. And their dream is in danger of becoming, well, not a nightmare, but perhaps a drag on their lives.

Their business has reached the point where it needs them to morph from being business founders to business managers. What’s the difference? And what must they do?

Business Founders Get Us Started

Business founders exercise the right side of their brain: they imagine and create new things; they obsess over details and make things perfect; they listen intently to their customers and are very sensitive to their needs; they sacrifice their time, family and money to bring their dream to life.

All good. All necessary. But financially unsustainable without the business manager side of their brain.

Business Managers Drive Us Onward

The business manager takes a dispassionate view. She recognizes that vision and creativity and customer responsiveness are only half of what’s needed to make a successful business. The business also needs discipline and a bottom-line focus.

Which means making only what sells. And raising prices. And letting some customers go. And recognizing that newly hired people won’t, CAN’T, do the job the same way we do, and that that’s okay.

It means balancing creativity with cash flow. Which often feels like a real conflict at first.

It means getting out of our own way.

We need to ask our Founder, who has been the dominant force for so long, to step back a little and allow our Manager to step forward.

This doesn’t mean that vision and creativity and perfection and customers are no longer necessary. Far from it. It only means that we need to recognize the cash flow imperatives of the business in addition to vision and creativity. It means that we need to integrate cash flow into our thinking. It means understanding that cash flow discipline doesn’t dilute our vision and creativity, it supports it.

Cash flow discipline supports our vision, enhances our creativity, and spreads our values and ideals further than was previously possible.

So let’s have a quiet word with our Founder. Let’s honor her passion, her commitment, her hard work. Let’s recognize her sacrifices and celebrate her successes. Thank you, and well done!

And now, as the business transitions to its next level, let us also transition. Let’s ask our Manager to help us rekindle our focus, our discipline and our determination. A determination to create a thriving business with solid cash flows that pushes the Founder’s vision and dream further than we could ever have imagined.



Business Owners Can Improve On The Future

For Business Owners Only

As you now know, business owners are uniquely able to predict the future. By identifying activity flows and metrics, a business’s performance can be monitored and become very predictable.

But predictability is only half the battle. Smart business owners use this information to shore up weaknesses and double-down on their strengths.

To illustrate, let’s use the invoicing flow example from the last post. We predicted that we’d invoice $25,000 next month, get paid for $23,500, and collect this money, on average, 42 days after we invoice it.

Apart from simply predicting our future bank balance, we always want to ask, “Can we improve on it?”

Making Things Much Better

By asking why some customers don’t pay us, we learn that we don’t follow up on overdue invoices. We also learn that there’s a 6-day delay between our service people doing the work and our administrative people sending the invoice. What can we do about it and what will be the result?

What if we gave our service people iPads so they can create invoices instantly? And what if we changed our policy so that we get paid by credit card as soon as we finish the job? We can now predict this:

  1. The iPads will cost us $1,500.
  2. We’ll invoice $25,000.
  3. We’ll process payments for the full $25,000.
  4. We’ll pay 2% for credit card processing.
  5. We’ll get our money within 3 days.
  6. Our Accounts Receivable at the end of the month will be down to $2,500.
  7. Our bank balance will be $36,000.

Amazing prediction – and it seems quite plausible, doesn’t it?

Oh, here’s how we calculated the bank balance: we previously predicted a bank balance of $5,000. Subtract $1,500 for the iPads. Add the difference in Accounts Receivable from our first prediction ($35,000) and our second prediction ($2,50). $5,000 minus $1,500 plus $32,500 equals $36,000.

Now let’s look at our sales flow example:

  1. We spent $100 on FaceBook ads.
  2. Our ad was viewed 20,000 times.
  3. 200 people clicked on it and landed on a landing page on our website.
  4. 14 people clicked on our “Buy” button.
  5. 5 people purchased an item worth, on average, $37.

Using ratios is a great way to analyze metrics:

  1. 20,000 views that become 200 clicks is a 1% click-through rate (CTR).
  2. 200 clicks becomes 14 who intend to purchase (7%).
  3. Of these 14 people, 5 purchased (35.7% shopping cart conversion rate).
  4. 200 clicks becomes 5 purchases (2.5% landing page conversion rate).

And the most important ratio, the Return on Market Spend (ROMS): $185 in revenue divided by the $100 ad expense equals 1.85.

How could you increase your ROMS best? Improve your ad and improve your CTR? Change your landing page so that more people click the Buy button? Enhance the shopping cart experience so that people who click Buy actually purchase?

Make Things Predictable…

Look at your business as groups of logical flows. Attach key numbers to points on the flow. Gain insights into your business and start making predictions about all kinds of things, including bank balances.

…And Then Make Things Better

Compare your key numbers over time. Assess the affect of various decisions. Then correct, improve and double-down and, in so doing, predictably improve your business over time.

How Business Owners Can Predict the Future

For Business Owners Only

A little known fact but true: every business owner has the ability to predict the future. And our success depends on how well we develop this skill and put it to use.

To predict the future, let’s start with what we know for sure. Things like:

• If we don’t make sales calls (or have clicks on our website) we can predict that our sales will be $0.

• If we don’t send invoices to our customers, we can predict that they won’t send us any money.

• If our product is lousy and our service sucks, we can predict that we won’t get any re-orders or word-of-mouth referrals.

“Hey,” you say. “That’s not predicting the future; that’s just common sense.”

Okay, I say, then let’s flip those things on their head:

• If we make LOTS of sales calls (or have lots of clicks on our website) we can predict exactly what our sales will be.

• If we send invoices to customers, we can predict exactly how much money we’ll receive.

• As our product and service improves, we can predict exactly the number of re-orders and word-of-mouth referrals we’ll get.

“Not true,” you say. “I THINK those things should work, but there’s no way to make an EXACT prediction.”

Actually, there is.

We need to track the activity in our business by logical flows and create “prediction models”.

For example, let’s look at how our invoice flow accurately predicts how much cash comes in. First, let’s identify all the steps in the flow of activity:

  1. We provide a service to a customer.
  2. We send them an invoice.
  3. They send us money.

Second, we’ll track the details for each step. After a while we may notice that 94% of our customers pay (and 6% don’t). They pay us, on average, 42 days after we do the work. Now we can predict our future bank balance from the work we’re going to do next month:

  1. We’ll invoice $25,000.
  2. We’ll get paid $23,500.
  3. The $23,500 will trickle in over the next two months.
  4. Our Accounts Receivable at the end of this month will be $35,000.
  5. Our bank balance at the end of next month will be it’s usual $5,000.

Very accurate prediction, right? If you want to go one step further and improve this predicted future, click here.

Example 2: Predicting Sales Flow

In another example, let’s look at our sales flow, also called a sales funnel. Let’s imagine that we use Facebook ads to drive traffic to a website where we want people to ultimately buy something from our store.

(BTW, this could just as easily have been placing an ad in the newspaper to drive people to our retail store where we want them to buy something.)

The beauty of selling and marketing online is that everything can be accurately tracked with well known metrics like views, clicks and closes. In addition, every webpage a person visits is also known to us.

So, for example, let’s say our Facebook marketing budget for this campaign was $100 and we achieved this:

  1. Our ad was viewed 20,000 times.
  2. 200 people clicked on it and landed on a landing page on our website.
  3. 14 people clicked on our “Buy” button.
  4. 5 people purchased an item worth, on average, $37.

We received $185 in sales for a $100 investment in Facebook ads. Pretty good – what would happen to our sales if we double how much we spend in Facebook ads next month? Want to use sales flow information to drive up our sales? Click here.

Every business owner CAN predict their future because…

…every business can be divided into activity flows both large and small, both short-term and long-term. Sales, marketing, production, customer satisfaction, employee retention, and so on. The wise business owner identifies these flows very early, tracks key numbers, and reviews them with staff and suppliers regularly.

Over time, these flows become increasingly accurate. Over time, you’ll learn how the flows of your business connect to each other. I think you’ll find that your business is like the inside of an old pocket watch. Everything is connected, everything is turning, everything somehow works together to tell the time perfectly, or – in the case of your business – to create strong, predictable cash flow.