Managers today are bombarded with financial metrics—revenue, EBITDA, cost controls, margins, and more. While each has its place, they all tie back to one critical element: cash. Cash is the lifeblood of any business. Without it, operations stop—no matter how strong your profits look on paper.
Cash is More Important Than Profits
Many banks and investors are focused on EBITDA (earnings before interest, taxes, depreciation and amortization) and there is good reason for this, but EBITDA should not be the top priority. In fact, it isn’t even a distant second.
In its purest form, EBITDA is an estimate of cash flow, but in practice it is an imperfect estimation. It is often adjusted by management to measure goal achievement or one-off events such as reductions in force, making it even less useful. Let the banks and investors watch the EBITDA, you should watch your cash instead.
Knowing Your Cash Balance Isn’t Enough
It’s not enough to know how much cash you have in the bank. Good cash management means understanding:
- How cash changes over time
- When those changes happen
- How much you need to sustain growth
The tools that answer these questions are in your cash flow statement. It is often the least used and the most misunderstood statement, but understanding its value is key to supporting your growing business.
What Does the Cash Flow Statement Show?
First, a cash flow statement is very different than a profit and loss statement, but they both measure your business over time. A profit and loss statement measures how much paper profit you made in a particular period, whereas a cash flow statement measures what happened to your cash over that same time frame.
There are three main sections to a cash flow statement:
- Operating activities
- Investing activities
- Financing activities
The operating activities section is important because it tells you how much money your growing business needs! In the purest sense, it is how much profit you had, plus your increase or decrease in inventory, receivables, and payables.
A growing business typically needs a lot of cash to support the growth of receivables and inventory, regardless of how much profit you have. The faster you grow, the more money you need to invest in your business to sustain growth. This is okay, as long as you know where the cash is going to come from.
Investing activities are the hidden black hole and it can be easy to lose your way. You need to invest in your business – it will not last long if you do not. If you have a fleet, you need to keep it maintained. If you have machinery, it needs to be updated.
As you grow you need more vehicles, more machines, basically more of everything. This cash doesn’t really show up on your profit and loss statement, so you need to plan for it. Don’t overinvest and don’t underinvest either lest you find yourself writing a big check all at once. Keep a steady flow.
Also, if you are planning on buying other companies, you will need to understand where that money will come from. Don’t use your operating cash to pay for your acquisition plans.
Finally, financing activities provide extra fuel needed for operating and investing as your business grows. If you aren’t flush with cash, most of us aren’t, solid banking or investor partnerships can be critical. The purpose of this money is to provide cash to cover the needs of your operating and investing needs as you grow, nothing more.
Money from this source should never ever be used to cover any of your business losses. That is a one-way ticket to trouble. This money is also expensive. Investors expect returns and banks will get their interest. Your growing business needs this money, but make sure you and your partners are on the same page and that your agreements are sufficient for your cash needs.
Forecasting Cash Flow: Looking Ahead
It is important to know where you are, but it is even more important to know where you are going. This is where many businesses struggle, but it does not have to be this way.
Most businesses are great at projecting a profit and loss statement, but, to master your cash, you need to become just as good at projecting your balance sheet. Yes, your balance sheet is key to cash flow forecasting. It is actually much easier than most people think and a good accountant can help a lot here.
The secret is to keep it simple. Don’t try to predict every expenditure; instead try to project what your total payables balance will be or how much receivables you will have. You can do this if you know what your DSO (days sales outstanding) or accounts payable days are and then project them forward.
Once you have a forecasted balance sheet, you also have a forecast of your cash flow statement. This forecast tells you exactly how much money you will need for operating, investing and financing. Now that you know how to read the cash flow statement, you know how to read your cash flow forecast too!
The Bottom Line on Cash Flow Management
Strong cash management is what separates good leaders from great ones. Take the time to understand your cash flow statement and use it to forecast where your business is heading. Mastering this discipline will put you on the path to sustainable growth and long-term success.
Allen Riggs is the chief financial officer at PSA Network.
