Why You Need Both Profits and Cash To Survive
Originally published: 03.01.12 by Ruth King
Planning for cash needs is as important as making a profit.
I received this question from a reader:
Lets say you have a loan you are repaying — $10,000 total; $9,000 to principal, and $1,000 to interest. The only thing that shows on your P&L is the interest. The principal is reduced on the balance sheet. But if you are managing the company off the P&L, you are going to be light $9,000, so it's not really an accurate picture. What’s going on?
Many of you probably have the same question. You manage profitability from the profit-and-loss statement. You manage cash and cash flow from the balance sheet.
Each month your P&L tells you whether you earned a profit or had a loss. It does not tell you how much cash you have! You must turn your profits into cash by collecting your receivables and paying the expenses incurred to produce those revenues.
Unfortunately you can be profitable and go bankrupt. How?
- A builder, general contractor, or someone else doesn’t pay you for your profitable work.
- You grow profitably so quickly that you run out of cash.
- You are drawn into a lawsuit (through no fault of your own) for profitable and correct work that you performed or someone getting hurt on a job.
Profitability does not ensure business survival. Many contractors have a month or two months that are not profitable. Others have an unprofitable quarter and work the rest of the year to make up the losses. What they aren’t realizing is that they are also working the rest of the year to generate the cash they need to survive that quarter the following year.
So what do you do? First — be profitable. Without profits you won’t generate the cash you need to survive and thrive. Second, determine your cash needs each month. You can calculate the cash you need from a cash-flow projection. The format for a typical contractor is shown in the table.
Note that the cash-flow statement looks at collections from sales — not the sales themselves. So, if you collect COD for residential service and replacement, then the sales for the month should equal the collections for the month. Commercial collections are 30 to 60 (and sometimes 90) days after the work was completed. So, you might have a sale in January and not get paid until March.
COGS is the cost of goods-sold disbursements — labor, materials, subcontractors, commissions, etc.
Good managers manage both profitability and cash. You need both for a successful business.
Articles by Ruth King
Your Acid Test - Do You Have Too Much Inventory?
Your Acid Test - Do You Have Too Much Inventory? Track This Indicator to Get a Clearer Financial Picture
Do You Have Enough Cash to Pay Your Bills on a Long-Term Basis?
Check Your Liquidity Ratios
Why I Hate KPIs
Comparing KPI ratios to industry standards alone can be a risky move.
Finishing and Implementing Your 2014 Three Page Business Plan
In the past two months you’ve created your 2014 goals with your employees and your 2014 marketing plan. This month you’ll complete your three page business plan by estimating your 2014 budget. I’ll end this series with some implementation suggestions so that you make 2014 your best year ever.
Four Steps for Developing a One-Page Marketing Activities Plan
How to create page two of your three-page 2014 Business Plan