Several years ago, a business owner of a $3 million specialty contracting firm called me because his P&L looked great but he didn’t know where the cash was going.
Have you added new contracts causing your receivables to go up? “Yes.”
Are inventory levels going up and are your payments for work in progress occurring faster than when you receive customer payments? “Yes, how did you know that?”
Bought any new trucks lately? New equipment? Have you started making loan payments? “Yes, I have.”
Did you just bring on a couple of new staff members? “I added one the month before last so we could support this new contract.”
Just curious, have you increased your draws? “When can you come to visit me?”
You Are Probably in Pretty Good Company
Several years ago, Karen and Joe Knight reported that about 70% of a sampling of C-level executives could not pick the correct definition of “free cash flow.” That’s scary, but I believe this based on my experiences with small to mid-sized business owners over the years.
When it comes to decision making, the norm is shooting from the hip on most business decisions requiring cash outlays. And then CEOs wonder how they were blind-sided with severe cash flow crunches that could have been projected weeks, maybe months earlier, with careful and deliberate planning. Shooting from the hip is easier, but it’s more painful in the long term.
You Need Cash Flow Intelligence
Of the scores of books I’ve read on cash management, Cash Rules by Bill McGuiness ranks near the top. This obscure book includes a pair of quotations I particularly appreciate.
Knowledge of cash-flow dynamics should be a qualification for virtually any responsible job in your organization. This doesn’t mean that you need a company full of accountants, but you do want each key player to see and understand the cash-flow issues clearly. Each one should have a definite awareness of how his or her personal effectiveness and efficiency affect your company’s cash flow. Accomplishing this goal involves some basic education and training, as does any new discipline.
Many small- and medium-size organizations think they cannot afford a trained and experienced chief financial officer. In fact, they cannot afford not to have that kind of expertise. But even among those companies that do have skilled CFOs, there is no guarantee that the cash-flow way of thinking will get integrated into the organization. The fact is that everybody on your management team needs to understand how cash-flow dynamics affect his or her department if your business is to prosper in the long term.
I agree on both counts. And this is why I appreciate Shawn Burcham of Missouri-based PFSbrands. Under Shawn’s leadership and guidance, every employee not only understands the numbers, but they are empowered to make decisions that can lead to favorable impacts on both earnings and cash flow.
Shawn will be the first to admit there was much shooting from the hip in his early days, but that financial training throughout the organization would be tantamount in order to remain cash flow positive where his business now enjoys double-digit sales growth every year.
Can You Ace this Test?
Not every CEO is a Shawn Burcham. Accordingly, try these questions on for size to measure your cash flow intelligence.
1. What’s Your Projected Cash Balance?
What do you expect your cash balance to be in one month? In two months? How about three months?
If you do not know, that means you are not forecasting your cash on a regular basis. My best clients are relentless in projecting their cash flow ranging from 4 weeks to 90 days. When the cash till is overflowing, sometimes the habit will be dropped, but these same CEOs in these cash-rich situations have an uncanny ability to know when they are getting off track from a cash perspective.
My recommendation–forecast cash every week at least four weeks out. Eight weeks out is even better. I’ve found that accountants generally do not like doing these forecasts because they want perfection. Trust me, it’s better to be 70% right than to be 100% in the dark.
2. What is your handful of indicators predictive of success?
Does your finance or operations team provide you 5 to 7 key metrics daily or weekly that can help you to monitor and manage your business? If so, the real question is, can you recite those metrics and what is driving the short-term trends of those key numbers?
My very first consulting client was an injection molder. He cared about one number, just one. Machine hours. I found that odd as I was a bottom line guy all the way. His explanation was that he knew his costs so well that by knowing his machine hours each day, he could recite the top, middle and bottom lines with a strong degree of accuracy by the time the financials came out. He was usually very close.
Knowing that one key number told him if his marketing function was deficient, if labor productivity was slipping, or if his machinery was not firing on all cylinders. His staff was so well trained that his key number was supported with a “why” behind every negative trend in addition to suggestions on how to resolve it.
I find it amazing how one little number can drive a staff to extraordinary results in a business world that generally lacks financial intelligence.
Ace this question, and you are a member of a very select few. While this question may not seem cash-like, the correlation between great metrics and cash flow management is high. That applies to the topics in the following three questions.
3. How timely are your meaningful financial statements?
Do you receive meaningful financial reporting by the third or fourth day of every single month, and if so, what is your trailing 12-month, nine-month, and three-month profit before taxes along with operating cash flow and free cash flow?
When I became a Free Agent CFO™ in 2001, I decided I was going to deliver financial intelligence in the same way that was found in much larger organizations. I was taken aback when my second client told me, “Mark, this is the first time I’ve ever understood my numbers.” At the time, one of the most prominent CPAs in his town was generating his monthly financials. Incidentally, he’s still a client today, and probably one of the most financially intelligent CEOs I’ve ever served. He went on to say his banker passed around the reporting because they were not used to that type of management analysis.
Meaningful financial information is critical. It leads to better decision making. From chaos to clarity. That’s what happens to the CEO who is provided reporting that finally makes sense. Furthermore, cash is far easier to manage and forecast with meaningful financials that are available that first week of the new month.
4. Are you constantly managing the gap?
After you receive your financials, are you then analyzing your actual results against your planned numbers? And immediately thereafter, do you roll your profit plan over a 12 or 18-month time period? If so, what are your targeted sales 12 months out? How about 18 months? And how about pre-tax profits?
The ability to model your business using key revenue and cost drivers with a reasonable degree of accuracy is the ultimate in achieving financial intelligence. You will never be a business winner just by forecasting sales and profit margins over time. But the insights you will gain from this process cannot even be measured.
When you follow this easy exercise each month, spotting liquidity problems on the horizon can be dealt with proactively.
5. Are you constantly growing the value of your business?
Can you measure the value you are adding to your enterprise on roughly an annual basis? If so, by how much?
This question is hard because you cannot enter a ticker symbol at Morningstar’s site and find the market value of your business today. But you should have a general idea of how a strategic buyer would price your business.
By having a clear exit strategy in mind and knowing how the process works, you should know what you could receive in a planned and orderly exit. And if you do, you can focus on the drivers that lead to increased value in your business.
Incidentally, the correlation is high between a growing business value and healthy cash balances.
How Did You Do?
Don’t worry. There’s hope for you.
My suggestion is to pick one area per month and learn all you can on that topic and put that new knowledge into action. Then continue the process indefinitely.