There are many different “drivers” of cash flow in your business. By “drivers”, I am referring to the primary financial categories in your financial statements that influence and reveal the flow of money into and out of your business.
This image shows the general categories of cash flow drivers.
These are the different drivers of cash that you will encounter as you complete the Cash Flow Focus Report each month. You will not run into all of them in a particular month because we are only focusing on the three largest changes, or drivers, of cash for each month. As each month goes by though, you will eventually see each one of these.
This is the part of understanding your cash flow that requires some work. Understanding each of the drivers of cash flow means that you will learn a bit about how financial statements work. I know that might sound boring and painful. That’s why I created the Cash Flow Focus Report.
The beauty of the Cash Flow Focus Report is that you get to learn about each driver in bite-sized chunks. A little bit each month. Trying to learn about all of them at once is like trying to drink water from a firehouse. It doesn’t work (and it’s not real smart). We’ll do it in baby steps. A little bit at a time.
I will talk briefly about how each driver works in this post. My objective is to make this discussion more of a reference guide that you can come back to when you need it. You can come back to it when you are completing your focus report and you have a question about one of your three largest drivers of cash.
Here is a short description of each driver of cash.
Profit or Loss – I am defining profit or loss here as sales minus expenses. The “bottom line” on your P&L. You will also see this referred to on your P&L as net income or pre-tax income. I am simplifying the term a bit and just referring to it as profit or loss. Over time, profit is the most important driver of cash. Consistently making money and turning those profits into cash in a speedy fashion, is the key to generating a healthy cash flow. But remember, profit does not equal cash. And this is especially important to consider when looking at cash flow for a particular month. You can show a nice profit for the month and still see a decline in your cash balance for that same month. Consider a business that sends an invoice to their customer for services provided and that customer has thirty days to pay the invoice. The invoice to the customer may have contributed nicely to your overall profitability. But if the invoice was not paid by the customer in the same month, then that profit in your P&L produced zero cash for the month.
Accounts Receivable – Accounts receivable represent amounts billed (invoiced) to customers. It means you are recording sales and profit before you actually get paid for the sale. It is not unusual for customers to have thirty days or more to pay invoices. If you invoiced your customer $10,000 on March 31, you might not receive payment until April 30 or after. In your Cash Flow Focus report, when accounts receivable is one of your three largest drivers of cash, the number you will be entering is the change in the accounts receivable balance for the month. Entering this amount “adjusts” for the sales and profit that did, or did not, turn into cash for the month.
Inventory – When you buy inventory that you will later sell to customers, the purchase of that inventory is recorded as an asset on your balance sheet. It does not become an expense in your P&L until the inventory is sold. You are buying inventory, paying for inventory, then selling it to customers. The time between paying for the inventory and ultimately being paid by your customer can tie up a lot of cash. When inventory is one of the three largest drivers of cash, the number you will be entering is the change in the inventory balance for the month. Entering this amount “adjusts” for the net impact of buying more, or selling more, of your inventory than what landed in your P&L as an expense for the month.
Accounts Payable – You have accounts payable when you record a vendor invoice in your accounting system but have terms that allow you to pay the invoice later. An example might be a utility bill. You receive an invoice for the services provided in the prior month but have ten or more days to pay the invoice. When accounts payable is one of the three largest drivers of cash, the number you will be entering is the change in your accounts payable balance for the month. Entering this amount “adjusts” for the expenses or purchases that did, or did not, get paid during the month.
Capital Expenditures – A capital expenditure is the purchase of a large asset like a vehicle, or a building, or a leasehold improvement that is not recorded as an expense in your P&L at the time you buy it. It is recorded on your balance sheet as an asset. When capital expenditures is one of the three largest drivers of cash, the number you enter is the amount of those “capitalized” assets you bought during the month.
Owner Distributions – Distributions of cash to the owners of the business generally fit into one of two buckets. The first is distributions to owners so they can pay the income taxes on the profits (taxable income) coming out of the business. If you are a sole proprietor or your business is set up as a “passthrough” entity, like an LLC or S Corporation, then the payment of income taxes falls to the owners of the business. Not the business itself. The second bucket is distributions of excess cash to the owners. I define excess cash as money that is not needed in the business for reinvestment or growth. Distributions of excess cash are the return on investment you earn as an investor, an owner, of the business. It’s the secret to creating Happy Owners.
Debt – I include debt with third parties as well as debt with the owners of the business in this category. Borrowing money brings cash in the door but it does not impact profit. It is recorded on your balance sheet as a liability. Paying that money back (the principal portion) sends cash out the door but it does not impact profit either. It “pays down” the liability. It reduces your debt. When debt is one of your three largest drivers of cash, the amount you enter is the net impact of debt for the month on cash. If you borrowed $150,000 on a new loan and paid $5,000 of payments on existing debt, the amount shown for the month would be $145,000. Debt is unlikely to appear as one of the three largest drivers unless you are paying down debt aggressively (high five if you are) or borrowing heavily each month.
Other “Timing” Differences – There are a number of other categories of financial transactions that create “timing” differences between when an item impacts your profit and loss and when it impacts cash. Things like depreciation and amortization, accrued expenses, deferred revenues, changes in other asset and liability accounts, and more.
Understanding the Drivers of Cash Flow – Profit and Loss
In my next post in this series, I go into more detail 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.
And I share some tips and strategies to help you improve your profitability.
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.
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.”