Cashflow vs. Profitability
by David C. Baker
The first step toward an improved business environment is stepping out of
denial with a deep sigh of relief as you begin to use new found energy
to fix the problems instead of mask them. We all have ways of talking
about specific situations that make them a bit more palatable.
One
example we see frequently goes like this: "We've been having some cashflow
difficulty." By definition, cashflow difficulties are rare. If your
cashflow difficulties are recurring, what you really are struggling
with is profitability, not cashflow. That's a very important distinction.
Very
profitable firms can have an occasional bout with cashflow disease.
For instance, a client might withhold payment on a large bill; a major
project might have to be scrapped; or a key person might leave the firm.
On
the other hand, firms that consistently struggle with cashflow cannot,
by definition, be profitable in any real sense. But we talk about "cashflow
difficulties" because that phrasing makes it seem like we are being
tossed by the vagaries of the marketplace, as if somehow this is a problem
that is out of our control. And
there seems to be little connection between volume of work and cashflow
struggles. Some of the clients we help are terribly busy but still not
profitable. Those are often the firms that have misunderstood marketing
(marketing is about control, not growth).
Why
is this important? Back to the original point. Unless you admit that
the core problem is profitability, you'll make unwise decisions about
cashflow. That might mean incurring fixed obligations when you can't
afford them just to get out of the immediate crunch (credit line abuse;
leases for depreciating assets; etc.)
Here's
a suggestion. Don't manage your business based on cash in the bank.
It's important to have it (at least two month's worth of overhead),
but it's far too close to the events at hand to provide
any meaningful information on the health of your business. Think of
measuring cash as measuring how hungry you are at any given moment.
One cheeseburger will fix it, at least temporarily. And
don't even pay too much attention to your income statement either.
It's a much better indicator of your health (if it's on an accrual basis),
but it still gives you information about recent, short periods of data.
And it doesn't fully account for what you do with the money once you
get it.
Think
of measuring profitability as getting on the scale to check your weight.
If you had a supersized
drink with that cheeseburger, you are going to weigh two pounds extra,
whether it was water or 250 calories of drippy sweet cola.
The
slowest moving and most accurate method of measuring your health
is to look at your balance sheet. Like nothing else, this accounts for
nearly all of the decisions you've made. More specifically, compare
your equity (assets minus liabilities) every quarter and chart it for
comparison purposes. Look at the direction of movement, not the speed
of movement. Think of this as measuring your body fat or taking a treadmill
test. One cheeseburger won't affect it, but a bunch of them will. So
you've read this far and buy the argument. You are busy, your clients
love what you do for them, but you're ready to join Cashflowers Anonymous
and admit that the problem is deeper.
Don't
you dare reach for that "raise our hourly rate" button! If you want
to position yourself higher in the marketplace, raise your rates. But
that's another subject. If
you want to make more money, though, quit subsidizing clients and start
charging what it really takes to get the job done. Until you fix that,
you'll be forever plagued with a problem that should be rare.
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