At the heart of building a wealth generating business is working to improve your profitability and cash flow. Most entrepreneurs have a pretty good handle on defining and tracking profitability. It's right there on the P&L.
But what about defining and tracking progress on your efforts to improve cash flow? And how exactly do you define "cash flow"?
Here is a great quote from Verne Harnish's new book, Scaling Up: How a Few Companies Make It… and Why the Rest Don't.
"Cash flow is an expression that is used in businesses every day: 'I have good cash flow.' 'I need more cash flow.' 'We need to improve cash flow.' Most businesspeople use the term to describe a general availability of cash. It refers to an almost intangible quality of a business. However, to a banker, cash flow has a specific value. It is a ratio that describes management competence. And that competence starts with you, the business leader, understanding the information that follows. If you don't, the money people will always have an advantage over you."
Scaling Up is a fantastic book that you should have in your office. It is the kind of book to read and constantly refer back to as you grow your business.
Much of the CASH section of Scaling Up was co-authored with Greg Crabtree. Greg wrote a wonderful book for entrepreneurs, Simple Numbers, Straight Talk, Big Profits: 4 Keys to Unlock Your Business Potential. This is another must-have book for the serious-minded entrepreneur.
In Scaling Up, they define cash flow like this:
"Cash flow is the change in cash and debt balances across a given period".
My personal preference is to define cash flow as the change in cash for the period.
Your job as the business owner is to understand the three largest drivers of that change in cash. You know you understand your cash flow when you can explain the change in cash in a 2-minute conversation.
Greg's definition is very helpful when you have a line of credit and you put most of your cash against the line. In that case, your cash plus the line of credit balance is a good measure of your total change in cash.
Profitability and Cash Flow
Defining profitability improvement goals and tracking your progress against that goal is straightforward.
Defining your cash flow improvement goals is different. It's about setting improvement goals for one or more of the key drivers of cash (including profitability). You have to dig below the surface of the financial statements to hone in on those drivers.
Step 1 to improving your cash flow is to make sure you understand your cash flow every month (and understand why an increase in cash is not always good and a decrease in cash is not always bad).
My online course, Understanding Your Cash Flow – In Less Than 10 Minutes, will help you get started. It turns an otherwise confusing topic into something that is simple and easy-to-understand.
Then make sure you get and read Verne and Greg's books.
Your profitability and cash flow will thank you. J
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