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CASHOS WEEK 2: THE 3 JOBS OF CASH
THE 3 JOBS OF CASH (and the Real Statement You Should Care About)read on smbfinanceos.com You’ve got cash in the bank, but what does it mean? Is it good, bad, or neither? Can it be spent? Or is it already committed to taxes, payroll, or equipment maintenance? For most businesses, these are unanswerable questions because they don’t have a good sense of their cash and cash flows. In this series, we’re going to approach this problem from a number of different angles so that in the future you can answer these questions with confidence. Today we’re going to address the first foundational skill to understanding your cash: The Statement of Cash Flows. We’re going to look at:
THE STATEMENT OF CASH FLOWSThe Statement of Cash Flows is the least used and least understood statement. The concept is simple: it’s meant to reflect how cash has moved through the business over a set date range. The formula is, in essence: Net Increase/Decrease of cash during period + Cash at beginning of period = Cash at end of period This ending cash Balance will tie to the Balance Sheet cash balance for the same date. The Statement of Cash Flows is an essential statement when running Accrual-basis Financials, yet it is often neglected. If you run Cash-basis Financials, this statement is irrelevant, as your Balance Sheet and Income Statement show cash movement. But, the concepts are still important to understand. The statement is broken into 3 sections:
Long-term, we want to see cash from operations get redistributed between investing and financing activities. How this goes depends on the type of business you have, but the concepts are still the same. OPERATING ACTIVITIESThis section contains 2 types of transactions:
With this, we’re trying to understand, based on the income-producing activities during the month, how much money actually made it to your pocket? INVESTING ACTIVITIESThis section highlights where we’re reinvesting in the business. Asset-heavy businesses will do this through the purchase of assets to fuel growth. This is also where we learn whether businesses are focused on organic growth or inorganic growth (acquisitions). We still can’t tell how they’re funding this growth, which could come from cash or financing. FINANCING ACTIVITIESThis section helps us understand the debt and capital structure of the business. We can see efforts to grow in the Investing section, but the financing section tells us whether that growth was funded by cash or debt. We also see stock-related transactions (was there an ownership change in the business) and dividends/distributions to the owner. Distributions aren’t bad. It just means the owner sees “higher returns” outside the business. I put it in parentheses because the “higher return” could be a vacation for the owner’s family. The reality is, sometimes this reward is needed to fuel the owner going forward. GIVE EVERY DOLLAR A JOBGive every dollar a job. I’m not the first one to use this concept, but I rarely see it applied in businesses. In fact, I’ve yet to work with a business that has applied this concept before we started working together. At a high level, every dollar serves one of these three purposes:
By understanding the Statement of Cash Flows, we start to understand this concept of giving every dollar a job. Let’s circle back to this statement. So, by understanding the Statement of Cash Flows, we can begin to understand cash movement related to operating and strategic cash, but we don’t really understand cash balances. In our framework, we want to make sure we understand both. So let’s break down the three types a bit. Most will treat all cash as operating cash, which is why so many businesses operate in a panic. Need a new piece of equipment? Oops, no cash… so we must finance is at 10%. Waiting on a big customer to pay? Oops, guess we must hold some AP so we can pay payroll. But operating this way is operating reactively. We want to operate proactively. By setting aside strategic cash, you give yourself options in how to grow the business. Do we finance or do we pay with cash? We can plan ahead and buy strategically. By setting aside reserve cash, we’re prepared for hard times. And those hard times will give you a leg up on competitors instead of fighting for survival. I’m always amazed at how many business owners are surprised by taxes when they happen each and every year on the same schedule. Even if you decide you don’t want separate accounts, as I referenced in the visual above, labeling your money each month is a valuable exercise. It also makes it easier to say no to ad-hoc requests that come in. Instead of treating every request individually, thus making it hard to deny, you can look at them in light of the plan. “Sorry, we only have $X of strategic cash, and it’s already allocated for the year. We’ll have to evaluate that during our planning for next year.” This is a lot better than just saying “no, because I said so.” It’s at this point that you’re acting as a leader of the business instead of letting the business lead you reactively. Imagine the clarity that comes with seeing $250,000 in the bank account and knowing:
Operating a business is still hard, but the peace of mind with this sort of cash management is game-changing. ACTION STEPSGo through the last 3 months of your bank statements (or transaction logs) and label each transaction:
Most debt payments should be labeled as strategic, as they’re deferring payment of an asset until later. You’ll find that very rarely are you actually “labeling” dollars as reserve dollars. Do this in a spreadsheet so that you can easily subtotal your spend by these columns. If on Accrual-basis Financials, compare these totals to your Statement of Cash Flows for the period. You should start to see trends around how you operate as a business. Later in this series, we’ll talk about this theme again and help you answer how much you should have in each bucket, as well as implement systems to manage it. Thanks for reading–see you next week, Work with meNeed more than this newsletter? You may not know, I have other ways we can work together. Check them out:
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