I have to confess something.
For a long time, I had no idea what the word “cash flow” meant.
I remember when I was a young adult, my dad was discussing his monthly budget. “You just have to understand cash flow,” he said matter-of-factly.
I stared at him for a minute before nodding my head. “Totally,” I muttered with enough confidence to keep him from prying further.
I hid my ignorance for a while. I didn’t even fully understand it in the early years of my business.
Cash flows in, cash flows out. Cash flow! Right?
It wasn’t until I stumbled on Profit First, the simplest cash flow system, that I finally began to understand it.
And boy was I relieved when I discovered that I wasn’t alone- most business owners had no clue what cash flow was, either.
Here’s the thing. As a business owner, you are the innovator. The dreamer. The creator. I’m going to go on a limb and guess accounting isn’t one of your primary gifts.
And here’s the other thing: cash flow is the #1 killer of small businesses.
So, allow me to breakdown cash flow in a way I wish someone would have done for me years ago (channeling the former 4th grader teacher in me now).
My definition of cash flow earlier wasn’t too far off- cash flows in, cash flows out.
However, as you know, business isn’t quite that simple. Some months more cash flows in than others. And some months more cash flows out than others.
If you were to go back and look at your last 12 months in business, odds are there were some ebbs and flows. Look at your biggest revenue month and compare it to your smallest revenue month.
This is the simplest snapshot of your cash flow.
If your business spends like every month is a big month, you would be in trouble.
Alternatively, you can look at your largest expense month and compare it to your smallest expense month. If you pretend all of your monthly expenses are equal to that small month, (and ignore annual fees, expenses, etc) you would be in trouble.
The secret to cash flow…
if you really want to win with money in business…
Is running your business based on percentages.
Pull out a Profit/Loss statement for the last 12 months and follow these steps:
1.- Find the percentage you spent on expenses by dividing your total expenses by your revenue.
2.- Find the percentage of what you paid yourself by dividing your total salary/distributions by revenue.
For simplicity’s sake, we’ll stick with these 2 steps for now.
Let’s say you made $500,000 last year and spent $300,000 on expenses. That means you spent 60% of your revenue on operating expenses.
In this scenario, every time income hits your account, allocate 60% to operating expenses. Whether you earn $100 or $10,000, 60% of it goes to operating expenses.
Do the same thing with your owner’s pay.
This will begin leveling out the cash flow beast. Whether business is good or bad, you have consistently in how the cash is managed.
Odds are your operating expense percentage will be higher than what I’d recommend. I have a short quiz that will help you discover exactly what percentages you should be using. Click here to take the free quiz.