An Open Letter to Business Owners

Business owners face an array of challenges to survive and thrive in today’s economic environment. Perhaps one of the greatest threats they face isn’t having enough cash to do what they need to do and when they need to do it, for the business to grow and prosper.

Lou Mobley, of IBM fame, once said that “you can operate a long time without profit, but you can’t survive one day without cash.” He understood all too well what many business owners are not aware of – profit is not cash!

Profitability isn’t a guarantee of business success or even business survival. Each and every year, far too many businesses struggle to the point of failure. Many were showing a profit in their financial statements when they were forced to close their doors. How could this happen? The answer is simply this – they didn’t have enough cash to stay in business. In effect, they ‘grew broke’. Cash is the underlying foundation of any business. Without a strong foundation, the business will eventually crumble under its own burden of growth. One of the questions bankers seek the answer to is how well the business is turning profit into cash. Bankers know how to measure the performance, productivity and profitability of a business, accurately and effectively. Unfortunately, many business owners do not. The reason why is the purpose of this open letter to all business owners.

Most business people are taught to manage profit. Very few are taught to manage cash flow. If you’re a small or growing company, operating cash flow is the very lifeblood of your business. The most critical period of growth for a business is from startup to realizing $5 million in annual revenue. Greg Crabtree, author of SIMPLE NUMBERS, STRAIGHT TALK, BIG PROFITS! refers to this timeframe as ‘the black hole’. “It’s during this time that you need to add staffing and infrastructure, but it’s also the time you can least afford it. The most challenging level of growth is from $2 million to $3.5 million in annual revenue. This is when you’re forced to add management infrastructure because it’s generally around this time when your company grows beyond 20 or so employees.” If a small company runs short on cash it struggles to survive. If it runs out of cash, it dies.

For a moment or two, let's take a deeper look into building and managing cash flow. Let's look at your business from a different perspective. Let's look at your business the way a bank does.

Judgment Calls: You Can’t Always Trust the Numbers

First of all, you must realize that things aren’t always what they appear to be. That’s certainly true when it comes to financial statements. Financial statements are composed of facts, opinions, estimates and assumptions. Your financial statements are only as good as your opinions, estimates and assumptions allow. It comes as a shock to many business owners that accounting is just as much an art as it’s a science. There are precious few black and white distinctions. A quick look back in history may help clarify the picture.

• 1929 witnessed the aftermath of the stock market crash and the ensuing Great Depression.

• In an effort to regulate the offer and sale of securities Congress enacted the Securities Act of 1933.

• The Securities Act of 1933 was followed by the Securities Exchange Act of 1934. In a sweeping piece of legislation, Congress instituted rules and regulations governing the trading of securities (stocks, bonds, and debentures). The 1934 Act also established the Securities and Exchange Commission (SEC).

• The SEC was entrusted with enforcing federal securities laws enacted by the United States Congress. Think of the SEC as the ‘watchdog of the industry’.

• In 1973, the SEC facilitated the formation of The Financial Accounting Standards Board (the FASB, pronounced faz-bee).

• FASB is a private, not-for-profit organization entrusted with the development of acceptable accounting standards.

• The SEC designated FASB as the entity responsible for setting generally accepted accounting principles for public companies in the United States.

• GAAP is an abbreviation for Generally Accepted Accounting Principles. It includes acceptable standards, procedures, rules and regulations accountants must follow in recording, summarizing and reporting financial information contained in financial statements. GAAP isn’t a single accounting rule, but rather a complex aggregate of how to account for ‘transactions’ incurred in business operations.

• Think of GAAP as the rulebook for playing the game of business.

The problem FASB encountered is that with so many different industries and so many specialized companies it’s virtually impossible to create hard and fast guidelines that would cover any eventuality. The best they could do is to formulate a generally accepted structure that could be enforced uniformly. Within GAAP, accountants are free to use their best judgment to render opinions, make estimates and formulate assumptions in the preparation of, and reporting of, the financial activity of a business. 

Grasping this scenario is paramount in understanding why, if five different accountants prepared your financial statements, you could conceivably come out with five different sets of numbers. All could be legal and correct in regards to GAAP. It all depends on the opinions, estimates and assumptions they make.

Separating Fact from Fiction: Spotting Opinions, Estimates and Assumptions

If that doesn’t give you cause for concern, it should. Because in running a business you need to have verifiable intel you can rely on to make smart decisions. If you don’t, you’re forced to guess when making critical choices. Guessing leads to wasted time, wasted effort and wasted money. A business cannot afford the continued wasting of resources and hope to survive.

So what do you do? Your initial step is to separate fact from fiction in your financial statements. You must be able to understand and interpret the story your numbers are telling you, so that you know beyond a shadow of a doubt what is fact and what’s based on opinion, estimate and assumption.

Verne Harnish, author of SCALING UP! How a Few Companies Make It…and Why the Rest Don’t, reveals the secret of separating fact from fiction in your financial statements. Please listen intently to his words of wisdom. 

“The only indisputable facts in any set of financials are the numbers that relate to cash. Your profit is an opinion, and data can be manipulated to provide a specific outcome. Your balance sheet is for the most part also an opinion; you can amend valuations to produce the desired result. Only your cash and debt balances are facts. Banks recognize this and use these numbers to determine your performance.”

If a bank looks at your business through the lens of cash and debt, business owners should too. 

Our Process: The Roadmap We Follow

Our 137 approach to building and managing business cash flow is centered around this philosophical belief. You should have 1 focus, 3 priorities and no more than 7 targeted objectives moving forward. If you have more than a single focus, you lack stability. If you have more than 3 priorities, you only have a list of things to do; and if you have more than 7 targeted objectives, you lose control. 

Let's apply the 137 approach to two areas of management effectiveness that will help you build and manage your business cash flow:

1. The right cash and debt drivers to track, and

2. The key financial indicators that will help you document your performance, productivity and profitability. (These key indicators can create a trend analysis table to measure your management effectiveness.)

Cash & Debt Drivers: What Bankers Are Tracking

Here are the right cash and debt drivers to track:

1 Focus:

The cash balances in all your accounts

3 Priorities:

1. Operating cash flow

2. Marginal cash flow

3. Cash flow (banks have a specific formula for cash flow)

7 Targeted Objectives:

1. Core capital (capital reserves)

2. Working capital (traditional & global)

3. Cash conversion cycle (how much cash is needed to run your business)

4. Free cash flow (Warren Buffett calls it ‘owner earnings’)

5. Net debt

6. Capital asset purchases

7. Creditworthiness financial ratios (current ratio & quick ratio)

These cash and debt drivers will guide you by showing you what path to follow, alerting you when you stray off course and helping you get back on track when necessary. In effect they are your roadmap to getting you from where you’re today financially, to where you want to be tomorrow.

Key Financial Indicators (KFI’s): What to Concentrate On

The Pareto Principle, better known as the 80/20 rule, states that not every action yields a proportional benefit. Some actions are more important than others because they result in greater benefits. The secret is knowing what to concentrate on and what to avoid. These key financial indicators can serve as your roadmap moving forward:

1 Focus:

Your 3 bottom lines. There are 3 bottom lines in business, not just one. They are:

1. Return on Assets (ROA)

2. Net Profit Before Tax (NPBT)

3. Operating Cash Flow (OCF)

3 Priorities:

1. Gross profit (this is your economic engine – not sales revenue!)

2. Cost of goods sold (your direct costs – do not include direct labor)

3. Operating expenses (overhead – your fixed expenses)

7 Targeted Objectives:

1. Salary cap calculation (know when you can afford to add staffing)

2. Labor efficiency ratios (LER’s – how productive is your labor?)

3. DuPont formula (combination of 5 financial ratios used to measure management effectiveness)

4. Days outstanding (Accounts receivable, inventory and accounts payable)

5. Principal and interest payments

6. Distributions and disbursements

7. Taxes paid and taxes due

By tracking these key financial indicators over time you can identify trends in your business and pinpoint your strengths and weaknesses in building and managing your business cash flow.

Building a Foundation: Build on Rock, Not on Sand

There are three fundamental commandments in building and managing your business cash flow:

1. See the big picture. The one thing no business owner can ever afford is to fool themselves. You must know what’s really happening financially in your business, why it’s happening, and perhaps more importantly what you can do about it.

2. Keep score and learn how to win. The skillset you want to build is the ability to forecast and quantify every situation. You must know where you’re at any given moment in time, and in which direction you’re moving.

3. Create a roadmap that will take you from where you’re today to where you want to be tomorrow. You must be able to identify what threatens your survival and avoid problems instead of continually having to solve one problem after another.

Blueprint for Building Your Business: Good Habits Build, Bad Habits Tear Down

If you’re serious about building and managing your cash flow, so that your business foundation is strong enough to sustain the weight of your growth, then here is a checklist of actions you should consider taking:

• See your business from three perspectives, not just one. 1) Market perspective [your returns], 2) Operational perspective [your management effectiveness], and 3) Funding perspective [your working capital]

• Measure your performance, productivity and profitability, accurately and effectively

• Develop an inertial guidance system to guide you in navigating your way

• Learn to speak the language of business, to communicate and understand financial cause and effect relationships

• Get accurate, complete and timely financial reports

• Understand the story your numbers are telling you

• Use your financial information to make smart business decisions about what you need to do. Don’t guess.

Help Yourself: A Collection of Free Resources

Finally, to help businss owners become anchored in financial reality, and build their business cash flow, we have a collection of free resources available for the asking. It can serve as your checklist of actions you need to take. Here is what’s available:

• Guide to understanding and interpreting financial statements (learn to speak the language of business)

• Blueprint action checklist (what financial reports are needed and when)

• Business owner self-test (identifies the strengths and weaknesses of your business)

• Business health quiz (tells you the current financial health of your business)

• Cash flow story sample case study (shows you what bankers look for – should be prepared quarterly)

• 11 milepost numbers (cash and debt drivers to track monthly)

• Trend analysis table template (key financial indicators over time)

• Excel templates and editable worksheets (to track your activity)

• Direct cash flow statement conversion template (this cash flow statement is the one report you really need)

• 91-page ebook – Running Your Business Like A Business (running a business isn’t the same as producing a product or providing a service)

• Bibliography (recommended resources – the ones we use)

Our Financial Rhythm Timeline: What Reports We Use and When We Use Them

As a postscript, here is the financial rhythm timeline we use. It’s our ‘what to do and when’ checklist.

• DAILY: Check cash balances in all accounts

• WEEKLY: Review your aged reports (accounts receivable & accounts payable)

• BI-WEEKLY: Cash flow forecast (two-week maximum prediction)

• MONTHLY: 11 milepost numbers (movement in cash and debt drivers)

• QUARTERLY: Cash flow story and variance report (trend analysis of your performance, productivity and profitability)

• SEMI-ANNUALLY: Debt and capital asset analysis (includes depreciation schedules)

• ANNUALLY: Distribution, capital purchase and tax analysis

By combining these elements you can create a business model to build and manage your cash flow. We are happy to share our thoughts with you on how we do it, and what you can expect.

Deciding Your Next Move

Your business is a reflection of the choices you have made, are making and will make in the future. If you want better results, you have to make better choices. Invest your time, effort and money in becoming more aware of what you need to do, and taking the appropriate actions to move forward. It’s difficult to run a business unless you know what the financial people are saying, and you understand the story your numbers are telling you. You can avoid problems in growing your business by following the facts, and not basing your decisions on opinions, estimates and assumptions. Always remember that the only numbers you can trust are the ones relating to your cash and debt balances. That’s what bankers do. Follow their lead. You will be glad you did.

Leverage Our Free Resources and Team’s Experience

Just contact us for any of our free resources, or to ask questions about our process to build business cash flow. 

You can reach us at our:

• Website: 137awareness.com

• Email: info@137awareness.com

• Phone: (405) 657-6889