Knowing when your cash inflows are coming in is foundational to reducing your anxiousness about meeting your cash outflows. Even if the amount of cash coming in is less than you need, Business CPR will help you know how best to utilize available cash as you work to improve your operating profits.
Adopt the BusinessCPR™ Management System to help you build cash reserves with less stress.
The degree of anxiousness felt about your business cash position is proportionate to your understanding of the amount and timing of cash inflows and outflows of your business. To better understand how cash flows through a business, consider how your blood vessels carry blood to and from all areas of your body to sustain your life.
The business equivalent of blood-sustaining life is cash. The cash your business generates flows through your operations to sustain your business. Cash flow from operations funds the everyday activities needed to make sales and deliver your products and services. Without cash flowing in from purchases delivered, you will never have the opportunity to earn the “P” for profits in BusinessCPR™ (B-CPR.)
Appreciating the significance of cash flow to your business
The American Heart Association defines cardiac arrest as “the abrupt loss of heart function in a person who may or may not have been diagnosed with heart disease.” See the illustration below to appreciate precisely how B-CPR starts with cash.
Understanding what cashflow means in business is best seen through four key factors required to effectively manage business cash flow that are part of healthy cardiovascular system:
- What happens to a business owner when cash is tight?
- Weak variable and fixed cost management are the drivers of cash flow problems.
- Understanding Gross Profit and Operating Income is the key to achieving cash flow stability.
- Profit problems will always lead to cash problems.
1. What happens to a business owner when cash is tight?
Business owners tight on cash suffer the same effects as a person with hypoxemia: low oxygen in the blood or, in B-CPR terms, low cash supplies flowing throughout their business. The “condition” of poor business cash flow creates restlessness in the owner and a lack of coordination across the business. These effects are due to confusion about what consumers will and won’t buy. The impact of business hypoxemia is particularly noticeable around payroll. Every time you are sweating payroll, your business is suffering a cash flow problem.
2. Weak variable and fixed cost management are the drivers of cash flow problems.
No business owner will be successful without an understanding of what their variable and fixed costs are. Every profitable business understands how to manage the two principal costs of running any business: variable and fixed costs.
Variable Costs will vary according to how much a business produces and sells. The costs for resources used to produce and deliver what you sell are called the cost of goods sold (COGS.) You know a cost is variable if it is only incurred whenever a sale is made. Common examples of variable costs include:
- Direct labor required to deliver a service or produce a product;
- Materials required to produce the product or support a service;
- Shipping and service delivery costs are required to get the product or service to the buyer.
Fixed Costs stay steady, regardless of how much a business produces and sells. It is considered a fixed cost if a cost doesn’t change regardless of a sale being made. These costs are considered “overhead” and are accounted for in selling, general, and administrative (SG&A) expenses. Some common examples of fixed costs include:
- Owner and office salaries;
- Rent and utilities.
Successful business owners are thoughtful and cautious in taking on new fixed costs because these costs don’t go away when sales slow. Profitable business owners are good at ensuring that both their fixed and variable costs to do business are being covered at a profit through their product and service pricing.
Other hard costs to be aware of are taxes and interest paid. These “costs of doing business” are imposed by the government or other agencies. As a business owner, you need to be aware of your tax and interest obligations and account for them when considering the pricing of your products and services. Failure to account for a variable cost, fixed cost, interest, or tax expenses in your pricing will negatively impact the profitability of your business every time, and your cash flow from operations will suffer as a result.
3. Understanding Gross Profit and Operating Income hold the key to achieving cash flow stability.
Profit is the money a business keeps after all costs are subtracted from net sales revenue. The first level of profit for every business involves subtracting direct costs, often referred to as the cost of goods sold or COGS from net sales. The calculation for gross profit is as follows:
Net Sales – COGS = Gross Profit
Gross profit margin is the percentage of money the business keeps after the variable costs are subtracted from the sales revenue. Below is the mathematical formula for calculating your gross profit margin expressed as a percent:
Gross Profit / Net Sales = Gross Profit Margin
The gross profit margin confirms how efficiently your business converts a sale into a profit, and it’s the number one determiner of whether you will have any operating income. Put another way, decreases in gross profit without corresponding decreases in overhead expenses will guarantee that you’re on track to losing money, not making a profit.
Operating Income is any money the business keeps after both variable and fixed costs are subtracted from net sales revenue. This second profit calculation is as follows:
Net Sales – COGS = Gross Profit – SG&A Expense = Operating Income
SG&A is referred to as Selling, General, and Administrative expense. These expenses are reflective of your fixed costs, those costs that don’t vary with sales. Subtracting overhead or fixed costs from Gross Profit results in every business’s second level of profitability, often referred to as Operating Income.
Another standard reference to Operating Income is EBITDA, which stands for earnings before interest, taxes, depreciation, and amortization. Knowing your EBITDA earnings is important because this figure tells you how efficiently your business operations are converting sales to profits.
Net Income is considered the “bottom line,” whereas Gross Revenue is the “top line.” Net Income is the money left over after accounting for every business transaction that occurred during the accounting period. Put another way, your Net Income is the profit made by the business that is available to be reinvested in the business or returned to you as the business owner. Below is the mathematical formula for calculating net profit and net profit margin percent:
Operating Income – Interest – Taxes – Depreciation – Amortization = Net Profit
Net Income / Net Sales = Net Profit Margin
4. Profit problems will always lead to cash problems.
If you aren’t earning 45 percent or higher Gross Profit margins, EBIDTA earnings that are 15 to 20 percent, and Net Profit margins that are at least 10 percent or higher, you are more likely to have cash flow problems. Businesses achieving these types of margins have fewer cash issues and most commonly operate in a market with high customer demand and the possibility for their businesses to grow.
Are your profits helping you build cash reserves?
If don’t have high-profit margins building cash reserves because your business is holding onto more cash than you spend, then take the “free” BusinessCPR™ Business Assessment to learn how healthy your business is. Click here to take this no-obligation business diagnostic.
Upon completing the business assessment, you will receive a risk profile showing how at risk your business is to suffer cash flow and profit problems in the coming year.
How healthy is your business?
If you have high-profit margins, you are likely building cash reserves in the bank because your business is holding onto more cash than it spends. If this isn’t the case for you, take the “free” BusinessCPR™ Business Assessment to learn how healthy your business is. Click the link below to take this no-obligation business diagnostic. Upon completing the business assessment, you will receive a risk profile showing how at risk your business is to suffer cash flow and profit problems, the primary cause of business cardiac arrest over the next three years.EXPRESS ASSESSMENT