Natural Entrepreneur: Financial Lessons for CEO's: 4,5,6

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Financial Lessons for CEO's: 4,5,6

More on the top ten lessons for CEO's and business owners

by Helen Dutton, A vision of Your Own, LLC, Weare, NH

In a previous issue, I outlined my Top 10 List of what non-financial CEO’s and business owners need to know about finance, and described the first few in more detail. Today we discuss Cash vs Income; Balance Sheets vs Cash Flow; and Debt.

4. Cash is cash; income is income.

Cash and Income are two separate elements of your business and it is important to track both carefully. Set your eye on how to increase and expedite both.

Over the years I’ve often heard disbelief from CEOs when informed their company didn’t have sufficient cash to cover bills due. Profits on paper do not necessarily translate to cash in the bank-- not immediately anyway. If you bill a customer instead of receiving cash, you create a receivable, or a promise from someone that they will pay you. If the customer has not paid by the end of the month, the income is not reported as cash on your balance sheet, but as accounts receivable. It will be reported as revenue, or income, on the income statement. The closer in time between when you pay out cash for bills and payroll, and when you receive cash from sales, the easier your cash flow will be.

Some tips on increasing and expediting cash and income include:

Carefully review your pricing strategy. Is your pricing determined by history? By competition? Does it reflect the benefit provided by your product or service? Be creative when looking at ways to increase your revenue and expediting customer payment, but not at the expense of profitability.

The next time you review business expenses, imagine the cash associated with each expense. A discretionary expense item loses some appeal when the alternative is a pile of cash! Consider delaying, or eliminating, expenses to increase cash levels. You may find that the desire for that discretionary item goes away just as any impulse would.

Be careful of the trap of increasing revenue without considering profitability. Investors require profit (more so after the dot-com era!) or income; as a business owner. It is essential for you to adopt the same outlook. When considering a new product or service line, absolutely forecast unit sales and project revenue. But also ask yourself whether the product or service be profitable and will it enhance your product offerings and, equally important, your bottom line?

While revenue is necessary, cash is the lifeblood of any business. This perspective can be engrained as part of the company culture, like the corporate controller of a national housing development company I once helped audit, who led the cheer of "Cash!" among the audit team in true game-show-host style!

5. Your balance sheet and cash flow statement tell you everything you need to know.

While they may not be as easy to understand as an income statement, the balance sheet and cash flow statements report the health of your business. Do not hesitate to ask a member of your financial staff or your CPA to explain this to you.

There is one simple truth about a balance sheet: it must always balance. Assets = Liabilities + Equity. Assets (what you own or a benefit due you) will always equal liabilities (basically, what you owe others) plus equity (the profits left in the company and what investors, including you, the business owner, have invested in the company).

A cash flow statement details how your cash balance changed from one period to the next.

Remembering that a balance sheet always balances, it makes logical sense that if you change one item on the balance sheet – in this case, cash – another item would also change. If you understand that completely you can make sound financial decisions. An example illustrates:

A business opens on August 1 with a cash balance of $500. During the first month, the business sells product and services in the amount of $1000 of which $750 is collected in cash at the time of sale and $250 is listed as an account receivable. Assuming no other transactions in the month, the cash flow statement will show how the cash balance changed from $500 to $1,250:

A cash flow statement will also break cash flow into three general categories:

cash used for/provided from operations (your day to day business),
cash used for/provided from investing in your business, and
cash used for/provided from financing to/from outside sources such as lenders, investors, and shareholders.

Ongoing operations should provide the cash needed for day-to-day business. If it does not, you may be operating inefficiently or need to revise your strategy. For more information and a better understanding of cash flow statements, ask your CPA. There are a number of resources available you can also reference, including the Small Business Administration at http://www.sba.gov/ and http://www.onlinewbc.gov/docs/finance/cashflow.html.

6. Debt for expenses or projects for which you have already received the benefit is never a good idea.

Debt should be used for products or infrastructure that is bringing cash in the door or that will bring future benefits to your business. For example, purchasing technology that will enhance your customer service and cut costs makes sense. However, using existing technology as collateral on a general business loan may not make sense. If your business is not generating sufficient cash to cover your cash requirements, it would be better to reduce your cash needs and not increase your debt.

An underlying assumption in basic financial accounting is called the “matching principle.” The matching principle states that each expense item related to revenue earned must be recorded in the same accounting period as the revenue it helped to earn. I like to apply this same concept to assets and liabilities, or rather, correlated benefit to incurring debt In other words, is the incurred debt resulting in a corresponding new asset (or equity in the form of net income)?

For example, lenders will shy away from approving loans based on collateralizing inventory to cover overhead and new inventory purchases, especially when existing inventory is not moving.

The cash flow statement will reveal whether day-to-day operations are covering day-to-day cash needs. If not, review your business model and consider operational and strategic changes.

Helen Dutton is a national business coach for fast growing and entrepreneurial businesses and principal of A Vision of Your Own, LLC in Weare, NH. She can be reached at (603)529-2345 or Helen@avisionofyourown.com. Also, visit www.avisionofyourown.com

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