It never gets old. Having conversations with clients or colleagues and hearing a version of the following:
“I don’t understand. Sales are up 10% over last year. Profit is up 15% over last year. But we are struggling to pay our bills and my income is the same or lower than last year.”
So we enter the ring and start asking questions.
How did sales increase this year? How much cash did you have to invest to produce that? How much did your costs to operate increase this year? What was your tax hit on the increase in profit? Did you have to make any capital expense investments this year?
This is about the stage where the eyes gloss over and we have to slow down and do a review session of basic business principles. It would astound you at how many times this happens and in the size of the organizations in which it happens. Rest assured, this sort of conversation is not just a small business issue.
In this day and age where software allows us to measure and report everything, the data overload leaders encounter is staggering. Knowing how to focus on the critical metrics and place the rest in the “that’s nice” category is essential.
Pop Quiz: what is the most important metric leaders need to understand to manage their business effectively?
Sales? Important, but no. Profit? Great to have, but again no.
The most important metric to any business organization is cash, and specifically cash flow. Understanding how cash will be produced or consumed and the timing on that activity is literally the lifeblood of any business. And it is ignored to the point of insanity. Allow us to explain in some detail.
There is no doubt that organizations grow only by increasing the topline metric, or sales. But sales is only the first important metric. Then you have revenue. Revenue is the number that goes into the profit & loss statement at the top and is telling you how much of the sales that have been made have actually been fulfilled and therefore “earned”. Think about it…making a sale doesn’t mean your work is done. It only means you now have the duty to perform a service or deliver a product to the customer. The completion of that activity is revenue.
You may have heard this old saying: “can’t save your way to prosperity.” Absolutely true. Watching the expenses is very important. But it doesn’t grow the business, it only produces profit.
Profit is an accounting measure that indicates whether your expenses are in line or out of line with your revenue. If expenses are lower than revenue then you have profit. If they are higher than revenue you have a loss. Now here is where most business leaders start to lose track of what’s important.
Did you know that it is possible to have a profit and no cash? Conversely, it is possible to have a loss and have plenty of cash come in. How?
Simple. When you generate revenue you send a bill to a customer. Depending on how long it takes them to pay you may have a perfectly legitimate revenue number on your statement, and having produced the product or delivered the service your costs to do so are also on that statement. From there you have either a profit or loss depending on how much your costs were. But if the customer pays you after you’ve already delivered and paid for the costs to do so, you are cash negative on that transaction until they pay you.
It’s called cash flow and it is the bane of most businesses. The problem, in our observation comes from too much focus on the wrong things and not enough on cash flow. Certainly, you can manage cash flow with cash reserves and credit lines. All businesses regardless of size have this issue. But only those that acknowledge cash flow and pay close attention to it daily end up successful.
So remember, having increased sales and solid profits are nice. They are important. But until all that converts to cash in your bank account, they do not mean anything to you because you can’t pay your bills with profit or sales. Only cash will do. Manage your cash flow, and see how much better you will feel and how much better your business will operate.
About On Brand Management
Chris Petersen is Managing Partner at On Brand Management, a diverse problem-solving firm offering local and regional businesses access to expertise normally reserved for global and national companies. Contact Chris at email@example.com. On Brand helps clients navigate today’s dynamic market by providing performance-driven solutions to sustain an organization’s stability and growth. On Brand has offices in Los Angeles, San Francisco, Chicago, Atlanta, New York, Washington, DC and St. Petersburg, Fl.