(Note: this is the ninth of a 10-part series listing my revised top 10 business planning mistakes. The list goes from 10, the least important, to 1, the most important.)
Make no mistake: profits are an accounting story, and cash is real money. You spend cash. Your business dies without it. Profits, on the other hand, depend on the timing on the books of sales and expenses. Following standard accounting guidelines, your sales are likely to be stuff you paid for months ago, that you won’t get paid for for months to come.
It’s November. You could easily be selling things you bought last July, paid for in September, and won’t get paid for until next April. That’s extreme, maybe, but it happens a lot.
All that would show up on the profit and loss would be the sales price, the cost of sales, and the expenses. The profit and loss records the sale when it’s made, not when the supplies are purchased. And it records the sale when it’s made, not when it’s paid for.
Not to mention that your profit and loss doesn’t give a damn about the money you spend to buy new assets, or to pay principal of debt; nor, for that matter, the money you bring in as new debt, or investment. That all happens outside of profit and loss — but it’s vital to cash flow.
So your business planning needs to project profits, yes, but also assets, liabilities, capital, and — by far the most important — cash. The financial calculations behind cash flow can be daunting at first, but they’re still vital. Just as another example, think about this: if you sell to other businesses instead of consumers, then it’s almost certain they’ll expect you to leave them with an invoice and then they’ll wait months to pay. That’s what goes on all the time.
A decent cash analysis will allow for the wait to get paid, and the need to buy things before you sell them, and the need to repay loans and buy new assets and other factors that affect your cash. Make sure you have a reasonable projection of the cash flow.
And if you don’t plan for cash — if you think profits alone will do it — then you can get into real trouble.