Lesson Two: Net Profit Does Not Always Equal Good Cash Flow

May 28, 2014

Debra Robinson, President of Centennial Revenue Management

 

The second lesson I learned about cash flow (the movement of money in and out of a business), comes from when I bought a business and a commercial property.  After my reign as a CEO of a multi-million dollar travel management company, I decided to buy an existing business and the commercial building it was running out of.   The financials looked reasonably good and the property was assessed and seemed like a reasonably good investment opportunity.

The business was a screen printing and embroidery business and the property was a stand-alone 14,000 square foot building.  We often had up to 20 employees at any one time and was screen printing 300,000 t-shirts for the American Cancer Society.  I had a lot of equipment that filled the warehouse.  All seemed like it should be a continued success story as described by the previous owner.

There were two separate financial transactions; one for the purchase of the business (existing customers) and all the equipment.  The second financial transaction was for the purchase of the property.  This resulted in two business entities I now became the president of; a Sub S Corp for the business, and a LLC for the property.

I was probably never going to get this business to cash flow, but didn’t know what I didn’t know.  I was determined and felt I had the entrepreneur skills to grow the business.  The first challenge happened in the first year when one of the 10-head screen printing machines had to be replaced.  That involved me having to scrap the old one and finance a new one.  Now I had to add more debt on to existing debt.  The second challenge was that I was not aware of how the debt affected my cash flow.  I was always watching the Profit and Loss and not much attention to the Balance Sheet where cash is posted on a monthly basis (i.e. payment on loans).  The third challenge was I did not understand my profit margins.  It sounds great to say we are printing 300,000 t-shirts for the American Cancer Society. Or we have so much work that we have a team of 20 employees to manage the work load.  What I didn’t know “I didn’t know”, was how much profit for each of these big jobs was affecting my cash flow and was I actually dropping to my bottom line?

As the years went on, the net profit was getting smaller and smaller.   The business owner in me kept thinking if I try this, or do that I can figure out a way to make more PROFIT.  (Still there was no focus on cash flow; only on PROFIT or Net Losses.) I had money that I was able to “re-invest” into the business.  That’s what I thought at the time.  The truth was I had money to keep the business alive.  I ignored the “writing on the wall”.  The last year owning the business the signs were there that I was having a cash flow problem.  I was having trouble making payroll, juggling vendor bills, collecting from customers and managing the debt.  Once again it was about not knowing what I didn’t know:  How do you understand the movement of money into and out of your business (cash flow)?  How do you explain why you are having trouble making payroll when your Profit and Loss are showing a small net profit?  Where is the money going?  Why is there uncertainty as to whether I am going to make payroll or not; if there will be enough money in the bank account?  Why is there less money each month when my revenues are increasing?

Cash flow is not about net profit or net loss.  It’s about the movement of money into and out of your business.  It’s about the movement of money on your P&L AND on your Balance Sheet.  It wasn’t until after I sold the business; sat on an empty building for a couple of years, and had a pity party that I couldn’t get the business to cash flow did I understand the lesson that I learned.  Lesson one was about understanding your financials.  Lesson two is about understanding the movement of money between the P&L and the Balance Sheet and the ability to forecast into the future.  The important part of this lesson was the concept of Cash Outlay per month against Projected Revenues.  Cash Outlay is not the same as total expenses on your P&L.  Cash Outlay has to do with how much cash is going out on a monthly basis that includes your expenses AND your principal loan payments, credit card payments, lines of credit payments.  All these things that are posted to your Balance Sheet are part of the Cash Outlay.

The challenges I faced in this business; adding more debt, not understanding how my debt was affecting my cash flow, and not having clarity on my profit margins for each job all are components of understanding your business’s cash flow.  If I could have identified my average cash outlay a month against projected revenues several months into the future, I would have seen that my business model was not sustainable.

Understanding the movement of money and how to accurately project cash outlay against projected revenues will definitely give you peace of mind at the end of the day!

 

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