A company can be profitable, and still go out of business. On the other side, you can run at a loss, and still remain as a going concern.
How is this possible?
Cash flow, that's how!
If a company doesn't derive its cash flows from operations, eventually, the sources of cash flow will run out, and the company will go out of business. Still, if you are well funded with access to capital, you can sustain an operation for quite some time, even while running at a loss.
A startup company with $8,000,000 in series A funding, and monthly operating costs of $100,000, can go quite a while without bringing in any revenues. A little over six years, to be exact. This is why it is so important to understand your Statement of Cash Flows. You don't need to know how to prepare one. You just need to understand how to read one, on the surface. With just the information I've shared with you here, you can look at a Statement of Cash Flows, and see the following:
- Cash Flows from Operations
- Cash Flows from Investing Activities
- Cash Flows from Financing Activities
If your cash flows are positive, and coming from operations, then you are in good shape. If they are coming from financing activities, then you are "on the clock." You'll need to start turning sufficient cash flows from operations, before the financing well dries up.
If a company is profitable, with a high amount of debt, they can still go out of business. Cash flows from operations can be negative, because the profits are needed to service the debt, instead of investing them into growing the business.
Too many businesses are stuck on the day-to-day, and they fail to do the most important thing. Cash Flow planning.
How much does it take to keep your business afloat every month? This is a number you should know. How much debt do you have, and how long will it take to pay it off? How much do you need to bring in, in sales each month? How long will it take to collect, and how much is enough to service your debt, and have something extra to put away for opportunities? How far off are you this month, from that target?
As a business owner, this is where you should be spending your time.
Most business owners spend too much time looking at the profit and loss. Where you should be looking, is at the Statement of Cash Flows, and then in the bigger picture, where do you expect your cash position to be in the next 12 - 18 months? Perhaps a better question is, where do you WANT your cash position to be, and how can you get there?
Now we're getting somewhere. Instead of a mindset that puts us at the mercy of where we think we will be, we flip the script, and look at things from the standpoint of where we want to be, and how will we get there.
The only way to know for sure, is to lay it all out, and the best way to lay it out, is using your actual chart of accounts. Watch the video for part 1 of how to create a cash flow forecast.