How to Build Cash Flow: Lesson 3 – Follow the Money… Not the Crowd
How do you see your business?
What do you look for to tell you how you’re doing?
What guides you in the decisions you make?
Some things are more important than others. Some actions yield greater results than others. Some contestants win more frequently than their opponents.
The Pareto Principle, better known as the 80/20 rule, states that not every action produces a proportional outcome. Perhaps nowhere in business is the Pareto Principle better illustrated than in the sport of Thoroughbred horse racing.
In Thoroughbred horse racing, a small percentage of the jockeys, trainers, and bettors outdistance the field by a wide margin. A few jockeys win a majority of races. A few trainers are profitable in the business. And a few bettors can earn a living at the racetrack. But why? What sets them apart from all those who struggle and fail?
If you know the answer to that question, you can build a profitable, cash flow generating business.
Why do very few jockeys, trainers and bettors excel in the thoroughbred horse racing business?
They don’t follow the crowd!
They have developed an edge over their competition through their education, action habits and discipline.
Your edge in business comes from:
Seeing the big picture, so you don’t fool yourself.
Knowing what to concentrate on, so you don’t waste time, effort and money.
Creating a roadmap to guide you, so you can avoid problems instead of continually having to solve one problem after another.
If you want to build your business cash flow, you must follow the money—not the crowd.
See the Big Picture: Look at Your Business from Three Perspectives
The first step in gaining an edge in business is to see the big picture so you don’t fool yourself. Fooling yourself leads to bad decisions, and decisions have consequences.
To see the big picture so you know what is really happening in your business, why it’s happening, and perhaps more importantly, what you can do about it, you must evaluate your business from three perspectives:
Performance
Productivity
Profitability
But how do you measure these accurately and effectively?
If you follow the crowd in measuring your performance, productivity and profitability, you’ll find yourself traveling down a dead-end street. “Most business people are taught to manage profit. Very few are taught to manage cash flow “ (Managing by the Numbers, p. 89). For a small business, cash flow is its very lifeblood. For an established business, cash flow is the best indicator of the quality of its earnings. Profit isn’t cash. To evaluate, track and determine how your business is really doing, follow the cash!
Do you see your business the same way bankers view it? A bank’s success depends on its ability to evaluate performance and determine the creditworthiness of its business clients. Their perspective is focused on management effectiveness and the ability to turn profit into cash so it can be used to grow the business and build wealth. “To a banker, cash flow has a specific value. It’s a ratio that describes management competence” (Scaling Up!, p.222). Bankers look for a business’s ability to stabilize its operations, build its cash flow and avoid ‘growing broke’ by running out of cash.
Most businesses struggle to have enough cash to do what they need to do, when they need to do it, to survive and thrive in business.
The root of the problem is the inability to use financial metrics to make sound business decisions. Not knowing which numbers to track to measure their performance, productivity, and profitability forces them to guess when faced with making critical choices. The numbers that drive the management and building of your business cash flow are the financial metrics you need to understand if you’re positioning your business to take advantage of opportunities that pass others by. “Cash is the most powerful opportunity magnet ever created” (Simple Numbers, Straight Talk, Big Profits!, p.51). Your cash and debt balances drive your business forward or hold its progress back.
Know What to Concentrate On: The Unspoken Secret Edge – The Pareto Principle
The second step in gaining an edge in business is to know what to concentrate on so you don’t waste time, effort and money.
The Pareto Principle states that approximately 80 percent of our results are produced from only 20 percent of our actions. Concentrating on the 20 percent that counts helps you accomplish more in less time, with less effort and less money. Unfortunately, most business people spend 80 percent of their time, effort and money on the 20 percent that is the least productive. If you follow their lead, you’ll struggle to survive in business.
Your financial focus should always center on your cash and debt.
“The only indisputable facts in any set of financials are the numbers that relate to cash” (Scaling Up!, p.220). Your balance sheet and income statement include opinions, estimates and assumptions. Decisions based on this information are only as good as the guesses made. The only facts you can rely on are your cash and debt balances. “Banks recognize this and use these numbers to determine your performance” (Scaling Up!, p.220).
But what are the numbers related to cash and debt that your business needs to focus on? There are eleven key financial indicators that will help you identify the 20 percent that really counts in building your cash flow and sustaining the growth of your business. We call them the ’11 Milepost Numbers’:
Core capital
Operating cash flow
Marginal cash flow
Cash flow--banker’s formula
Change in cash position
Current ratio and Quick ratio
Net debt
Days outstanding and Cash conversion cycle
Working capital
Interest and principal payments
Capital asset purchases, owner distributions and taxes paid.
[Lesson 4: Measuring What Matters Most will examine these ’11 Milepost Numbers’ in greater detail.]
“Knowing your company’s cash situation will help you understand what is going on, where the business is headed and what management priorities are” (Financial Intelligence, p.138).
Knowing your cash position means tracking where your cash is coming from and where it’s going.
But, how do you track your cash inflow and outflow effectively? The answer is your cash flow statement. Your cash flow statement tells you how much cash you generated from your operations, how much you invested or made from capital asset purchases and sales, and how much cash you borrowed or repaid. “Your cash flow statement is the one statement you cannot do without” (Managing by the Numbers, p.37).
Cash flow isn’t an abstract idea but rather a concrete truth to build upon.
Create a Roadmap to Guide You: It’s Better to Avoid Problems Than to Solve Them
The third step in gaining an edge in business is to create a roadmap that will guide you by identifying threats to your business survival and providing ‘red flag’ warning signals to alert you to impending dangers. It will enable you to avoid problems instead of continually solving one problem after another.
“A roadmap can be defined as a detailed plan to guide progress toward a goal” (Merriam-Webster Dictionary). To gain an edge in business, you must know where you’re, where you want to go, and how best to get there. The question to ask is this:
Do you want to follow opinions, estimates or assumptions and guess what you need to do? Or do you want to follow established guidelines that have been proven to withstand the test of time and know you’re on the right track moving forward?
The choice is to follow the crowd or follow the money.
We developed a checklist to help our clients, and those we’ve coached and mentored, create their roadmap.
Here are the steps we follow in our business practice and recommend to those who work with us; and the free resources we offer and use ourselves in each step:
1. Learn how to understand and interpret your financial statements
Your Guide to Understanding and Interpreting Your Numbers
2. Know what financial reports you need and when
Blueprint Action Checklist
3. Become anchored in financial reality – know what questions to ask/what numbers to track
Running A Business Like A Business [91-page ebook] – Your Guide to Building a Profitable, Cash Flow Generating Business
4. Evaluate your performance, productivity and profitability over time – trend analysis
Cash Flow Story and Variance Report [What bankers use to determine performance]
5. Identify your business strengths and weaknesses
Self Test – Detailed question and answer checklist for you to use on your own
6. Assess the health of your business
Business Health Quiz
7. Build your own resource library of trusted professionals you can depend on for advice
Bibliography [The one we created for ourselves]
8. Document the results of your actions and decisions
Excel templates and worksheets that you can format to fit your needs
9. Develop an inertial guidance system to stay on track
11 Milepost Numbers – A monthly checklist of your cash and debt drivers
10. Determine your creditworthiness before you need it
Checklist of financial ratios banks use to evaluate your business
11. Know where your cash flow is coming from and going to
Direct Cash Flow Statement [note: not the indirect cash flow statement]
Identifying threats to your business survival and heeding ‘red flag’ warning signals will help you steer clear of impending dangers and avoid problems altogether. Your edge in business comes from:
Seeing your business the way bankers see it
Using the Pareto Principle to know what to concentrate on, and
Creating a roadmap to guide you and help you avoid problems.
If you want to build a profitable, cash flow generating business, you have to follow the money [your cash and debt balances] and not the crowd.
About Us: We Build Cash Flow
Most businesses struggle to have enough cash. We have a process to help businesses build cash flow, so they can do what they need to do, when they need to do it, to survive and thrive in business. We have a free collection of resources to help build business cash flow. Click below to start browsing them now.
