I speak to a lot of business owners and managers. Some green, some very experienced. And I find that many simply do not understand the true financial position of their business. You might be shocked to hear it.
Some just don’t ensure accurate, timely financial reporting. I mean no P&L for months! Many others clearly do not understand the numbers put in front of them. Really. Even the difference between ‘Revenue‘ and ‘Gross Profit‘ eludes some of them. And plenty of others get lots of information, but focus on entirely the wrong data when they do look at it.
I am not being demeaning here. It took me years to fully grasp financial management, and I am only mildly proficient now. And I know that many people who rise to management roles have little or no financial training.
But if you manage or run a business, let me give you the word. You need to understand the numbers. And it’s more than just being able to read a P&L. You must not allow yourself to get seduced by numbers you see on a spreadsheet either.
Remember. It’s not numbers, percentages or ratios you put in the bank.
It is dollars.
And so I find myself cautioning disbelieving owners, celebrating a massive temporary PSA win for example, that they need to reject the contract. “But it’s worth nearly a million dollars!” they cry. “We have to do it!”
No, you don’t actually.
In fact you must not take it on at margins and payment terms that will cripple you. “But this will grow our sales by 25%” they wail. “And what we lose on margin, we will make up on volume”. Oh dear, oh dear, oh dear. What a seductive, but fallacious argument. If you are losing money on a transaction, greater volumes of that transaction just mean you will lose more money, more quickly. I have seen it countless times. Usually the cash flow implications will do the damage before the shitty margins get you.
And, increasingly, I find myself interrupting a self-satisfied Board meeting, where we are studying a gorgeous set of P&Ls, which show juicy profits. And then I go and spoil it all by asking for a balance sheet, a debtors aging report and a cash flow report. What a buzz-kill!
Smiles fade as we realise the ‘massive profit’ we have made this year does not correlate with an almost empty bank account, and massive creditors list to pay. (Often owing money to the government, an institution not known for patience or forgiveness in any country I have worked) Why? Because we are not collecting our debts in a timely way, or sometimes, we have not accounted for GST, BAS, Group Tax, superannuation, or some other statutory payment, which looms like a massive iceberg that many a recruitment titanic has failed to see
Look at it like this.
Revenue is only the bluntest of instruments when it comes to measuring business health. All revenue is not equal. We have to look at both margin and the cost of generating that revenue. So while obviously important to grow customers and sales, chasing revenue at the cost of all else is vanity and a potentially fatal blunder. I know companies with $50 Million in sales, who at the same time carry $5 Million in debt and make annual profits of $100k. I also know businesses with total revenue of $10 Million who are debt free, have $2 Million in the bank, and make almost $2 Million EBIT per annum. Which owner do you think sleeps better?
Profit is a far more reliable indicator of business robustness, but profit on a P&L can be misleading too! A rigorous P&L will give you a snapshot of your business performance over a set period of time, and it will tell you whether your business model is working. But ‘profit’, on a P&L, is still a mirage. It’s a fairy tale. It’s not real. Yet. You can’t pay next week wages with a set of financial statements, no matter what those statements say.
You need cash. Cash is the love of your life. Wad is God. Your one true friend. The one you can trust. Not everyone agrees by the way. I have been lectured by countless ‘high-flyers’, much, much cleverer than me, who tell me debt is good, using other people’s money is smart, and cash in the bank is lazy money. Most of them are bankrupt now.
Cash is reality. Make sure every ‘deal’ you plan to do, every new strategy, every new hire, is only ever agreed to, once you know the cash implications.
Most business meetings focus on revenue and paper profit. Yes, important, but always ask these 3 questions;
- How much cash do we have in the bank?
- What are our debtors and what are our liabilities?
- What is the cash flow projection of this initiative?
Cash is like oxygen. It’s not what we live for, but if it runs out, you are sure as hell going to notice.
Revenue is vanity. Profit is sanity. Cash is reality.
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- Posted by Greg Savage
- On July 14, 2015
- 4 Comments