Understanding the Drivers of Cash Flow – Profitability

Most business owners think that if they are making money (if the P&L shows a profit) they ought to have more money, more cash, as a result. That’s one of the biggest mistakes business owners make when trying to understand and manage their cash flow.

This image makes the point.

cash flow driver profiability

The graphic here shows you both the problem and the solution. The problem is there are a number of different factors (or drivers), in addition to profit, that have an impact on your cash in any particular month. That’s why your profit will never be the same as the change in your cash balance.

Having accounts receivable means you are recording sales and profit before you actually get paid on the sale. If you have inventory it means you are laying out cash and holding inventory before you can sell it to a customer. You have accounts payable when you record a vendor invoice but have terms so that you can actually pay the invoice at a later date.

A capital expenditure is the purchase of a large asset like a vehicle, or a building or an improvement that is not expensed at the same time you actually pay for it. And borrowing money is not income. And paying the principal of a loan back is not an expense. And there are a number of other differences between when revenue or expense is recorded in your P&L and when it actually impacts your cash balance.

This is why 82% of business owners don’t feel like they have their cash flow under control. They don’t know how each of these drivers impacts their cash balance each month.

Profit is Very Important

Profitability is a super important driver of your cash flow though. A business that does not consistently produce revenues in excess of their expenses is a business headed for the graveyard.

Profitability helps you generate the additional cash you will need to:

  • Reinvest in the business
  • Create the capital to grow
  • Pay down debt
  • Earn a higher return on your investment
  • Create financial freedom for you and your investors
  • … and make running the business fun – and rewarding!

Your financial improvement plans should always have action items related to driving revenues higher and expenses lower (and on ways to keep expenses from rising too fast).

Cash Flow Focus Report

The purpose of my Cash Flow Focus Report is to make the process of understanding your cash flow easier. It focuses you in on the three largest drivers (or changes) in your cash for the month (sometimes profit or loss is one of the three drivers – and sometimes it’s not).

This series of blog posts is designed to help you better understand what each of these drivers means and how to write your one sentence explanation of what happened.

The mistake is you can’t try to learn about each of these drivers all at once. Trying to learn about all of them in one sitting is like trying to drink water from a firehouse. And as a business owner it would bore you to tears trying to do that anyway. It doesn’t work (and it’s not smart).

I’ll help you learn about them in bite-sized chunks.

If you have not seen the recording of the webinar Understanding Your Cash Flow – In Less Than 10 Minutes, check it out real quick. It shows you the power of my new Cash Flow Focus Report and how you can put it to work in less than 10 minutes a month.

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