In this post, I’ll talk about how to write the one line explanation in your Cash Flow Focus Report, and determine whether the change is good or bad, when one of the three largest changes is profit or loss.
Profit (a positive number) – Your explanation about your profit should mention whether there was anything big or unusual that made your profit either larger or smaller than normal. I oftentimes mention whether the profit number is “healthy” or not because that is a good way to evaluate whether you are happy about the number or not.
Loss (a negative number) – The same consideration applies to a loss as to a profit. In addition, you should mention whether there was anything big or unusual that created the loss or was a big influencer on the amount of the loss.
Labeling the Change as Good or Bad – Deciding whether a profit or loss for the month is good or bad relates primarily to what you expected the number to be. If you showed a profit for the month but had budgeted or projected a much higher profit than what you achieved, you might mark it as bad because it means something did not go as planned. It might indicate that you have some work to do in the coming months to address the problem. If the number was a loss, but the loss is pretty much in line with what you expected because your business is seasonal, and you are generally on track with your profit goal for the year, then you would label it as good.
Let’s look at some examples. Here is an example from Lisa’s business.
Profit was one of the three largest drivers of cash for the month. Profit was $32 thousand. Her one line explanation of the change said: “Sales were up nicely, a number of large orders had shipped.”
That one line explanation was helpful for Lisa because it made it clear that the profit for the month was a nice number (higher than a normal month) and it was driven by an increase in sales from the large orders that shipped during the month. You want your one line explanation to serve several purposes. One purpose is to help simplify each driver of cash because it makes it easier for you to rate your cash flow for the month. Another purpose is to make it clear and easy to understand if six months from now you are looking back on your Cash Flow Focus Reports to see what was going on with your cash flow back then. A clear, to-the-point description makes it very easy to quickly see what happened that month.
Lisa labeled the profit driver as “Good” because she was happy with the profit number.
Here is an example from Hector’s business.
A loss (rather than a profit) was one of the three largest drivers of cash for the month. The loss was $119 thousand. His one line explanation of the change said: “Loss for the month on lower revenues.” Short and to the point. The loss wasn’t driven by a reduction in gross profit margin or an increase in expenses. The loss was due to lower revenues for the month. In Hector’s case, customer invoicing was down.
He labeled the loss driver as “Good” despite the fact that he showed a loss because he knew that the lower revenues were temporary. It was not a surprise and not overly concerning. The business is project-based and monthly invoicing to customers is based on meeting certain milestones for each project. It is not unusual for revenues to be down one month but bounce back in the next one or two months as progress continues. As a result, he normally has three months during the year that show a loss. But on an annual basis, the business is nicely profitable at about 15% of revenues (and he is paid a healthy salary from the business as well).
The Importance of Profitability
Here is an important point to keep in mind when looking at your three largest drivers of cash each month. You want to see profit show up in that list regularly. While it is not unusual to have a month where profit does not make the list of top three drivers, profit needs to be there often, or you likely have a problem that needs attention.
Over time, profitability is a super important driver of your cash flow. Profitability helps you generate the cash you need to:
- Pay down debt
- Replace aging assets
- Expand your business if you have plans to grow
- Distribute excess cash to you and other owners of the business
- Reduce stress and make the business more fun to own and operate
Here are some additional resources for you to explore on the subject of improving your profitability.
Here’s the deal, my friend: Profit is not an event. Profit is not something that happens at year-end or at the end of your five-year plan or someday. Profit isn’t even something that waits until tomorrow. Profit must happen now and always. Profit must be baked into your business. Every day, every transaction, every moment. Profit is not an event. Profit is a habit.”
Profit First – by Mike Michalowicz
I like how the author of Profit First describes profit as a habit. Because making money (generating a healthy profit in your business) is a skill. It is a skill that should be learned, practiced, and improved. And with repetition comes habit. Making profit a habit promotes financial health and wellness (and stronger cash flows) in your business.
Here is a super-fun interactive dashboard that reveals profitability margins for almost 100 different industries. Check it out and see how your business compares on profit margins.
The 5-Minute Profitability Assessment. This is a quick process to help you determine if your business is as profitable as you want it to be (or as profitable as it should be)?
You would be surprised what the general public thinks abut the profitability of businesses. Here is a question in a poll of the general public: “Just a rough guess, what percent profit on each dollar of sales do you think the average company makes after taxes?” The answers will shock you. I also show you what business owners consider the average profitability of the typical business.
This dashboard shows a big picture view of business success and failure rates over the last 10 years. This can be useful information to consider as you work on improving your profitability because it serves as a reminder of the importance of being consistently profitable over time.
There are four areas to focus on as you work to improve the profitability of your business. At any given time, you should be working on one or more of these areas to improve your profitability.
When was the last time you raised your prices? Pricing is one of the most important drivers of your overall profitability. You have to constantly evaluate the value you deliver to customers, the price you charge, and your obligation to generate an above average profit in your business.
Here is a quote I love from the book How to Sell at Margins Higher Than Your Competitors by Lawrence L. Steinmetz, PhD., and William T. Brooks
Have you ever worked for an unprofitable business? If you have, you probably learned that it’s not much fun. Perhaps people who work at unprofitable businesses should consider putting signs in their offices that say, ‘It ain’t fun if it ain’t profitable.’ If you have worked for both profitable and unprofitable businesses, we think you would agree it’s more fun when the enterprise is actually making money. We have never heard anybody complain about excessive frugality in successful businesses; but we sure have heard about ‘the need to tighten up’ in an unprofitable one.”
Another quote I love is from The Six-Month Fix by Gary Sutton
The function of a business is to create money, not consume it, and the longer you postpone this the harder it gets to fix.”
That quote reminds us that if we are not making money in our business… we are probably consuming it. And we all know that you can’t consume cash for long if you want to survive, much less thrive, in business.
The next quote is not from a book. It is from a talented small business owner who has navigated a changing industry and created a thriving, growing business. Lauré Poffenberger owns a niche travel agency that specializes in Destination Weddings and luxury travel.
Self-employed can equal unemployed if you are not focused on making money.”
That is wise advice for everyone running a small business. 😊
Understanding the Drivers of Cash Flow – Accounts Receivable
In my next post in this series, I talk about how to write the one line explanation in your Cash Flow Focus Report, and determine whether the change is good or bad, when one of the three largest changes is accounts receivable.
You have accounts receivable when you sell your products or services on terms such that the customer does not have to pay you at the time you make the sale. If that is the case in your business, accounts receivable will show up frequently as one of the three largest drivers of cash.
I will also share some tips and strategies for managing your accounts receivable more effectively.
Summary and Links to Other Posts in This Series
Here is a short recap and a link to each blog post in this series on making your cash flow simple and easy-to-understand.
Part 1 – The surprising results of my super-short survey that asked: “How do YOU define cash flow in your business”?
Part 2 – “Cash flow” is not a single number on your financial statements. Now is the time to totally rethink (and greatly simplify) how you go about understanding and managing cash flow in your business.
Part 3 – I use a VERY different, simple approach to defining cash flow. It is an approach where I take my CPA and CFO hat off and speak in a common-sense language that you can relate to.
Part 4 – The Cash Flow Focus Report is a simple, common sense tool for understanding your cash flow that takes 10 minutes a month. It brings focus to your cash flow, simplifies your life, and leads to an understanding and sense of confidence that you will find freeing.
Part 5 – The four reasons cash flow has always been so confusing and complicated for business owners (and for bookkeepers and accountants too).
Part 6 – I show you the 4-step process for completing the Cash Flow Focus Report. I walk through each step in the process using a real-life small business example. It’s a cool little company that was founded almost 20 years ago. It has grown nicely over the years and the owners love the business. Last month, the business showed a profit of $32 thousand. But their cash balance went down during the month by $6 thousand (from $116 thousand down to $110 thousand). The Cash Flow Focus Report shows what caused the change in cash.
Understanding the Drivers of Cash Flow – There are a number of different drivers of cash (in addition to profit or loss) that you will encounter as you complete the Cash Flow Focus Report each month. You will not run into all of them in one month because we are only focusing on the three largest changes, or drivers, of cash for each month. But as each month goes by, you will eventually see each one of these drivers impact your cash.
Philip Campbell is an experienced financial consultant and author of the book A Quick Start Guide to Financial Forecasting: Discover the Secret to Driving Growth, Profitability, and Cash Flow and the book Never Run Out of Cash: The 10 Cash Flow Rules You Can’t Afford to Ignore. He is also the author of a number of online courses including Understanding Your Cash Flow – In Less Than 10 Minutes. His books, articles, blog and online courses provide an easy-to-understand, step-by-step guide for entrepreneurs and business owners who want to create financial health, wealth, and freedom in business.
Philip’s 35 year career includes the acquisition or sale of 35 companies (and counting) and an IPO on the New York Stock Exchange.
Understanding Your Cash Flow – In Less Than 10 Minutes
This online course teaches you the step-by-step process for simplifying your cash flow. I walk you through each lesson while you watch, listen, read and try it yourself using your own cash flow numbers.
The course is very affordable. And there are also some coaching options available if you would like to get up and running fast.
It’s a fantastic way to learn the process.
I take all the risk out of your purchase because I include a 100%, no questions asked, money-back guarantee. You love it or you get your money back in full. Period.
There are two things that are very unique and exciting about this online course.
1. I’ll show you how to understand your cash flow in less than 10 minutes
2. I’ll show you how to explain what happened to your cash last month to your business partner or banker (or maybe even your spouse) in a 2-minute conversation.
I take off my CPA hat and I speak in the language every business owner can relate to. No jargon. No stuffy financial rambling. Just a simple, common sense approach that only takes 10 minutes a month.
Here is how one business owner describes the benefits of the course.
“I googled cash flow projections and found your website online and it appealed to me mainly due to the fact that you speak in laymen’s terms in a way that a non-financially trained person can understand.
The fact that you said you can understand your cash flow in less than 10 minutes a month was also a big reason I bought it. And the fact that you acknowledge that most accountants and CPA’s speak in terms that the normal owner cannot understand and that you would be able to put things in understandable terms really got me.
The monthly cash flow focus report was the best feature for me because learning to do it helped me understand my cash flow statements and the biggest drivers of cash flow.
Another significant benefit is the definitions of cash flow drivers and descriptions of how a negative or positive sway in cash within those drivers affects cash flow. Being able to see at a quick glance monthly what happened to your cash using the focus report is a huge benefit.”