In the 1996 movie, Jerry Maguire, there is a scene where the two main characters scream at each other: “Show! Me! The! Money!” This is a key scene and a rite of passage for Jerry Maguire. In small business, show me the money is also a key concept.
Yes, there is the obvious sales aspect to the phrase. As in, until you are paid, there is no sale. However, there is a deeper meaning that many small business owners ignore or are possibly unaware of and that is cash flow.
In a Facebook post I once asked: Which is more important, cash flow or profitability? And the answer is: it depends. (Yes, I love asking the occasional trick question. Get over it already.)
Hey, don’t click away yet. This is important stuff. And I promise to keep it as non-technical and un-scary as possible.
Let’s look at both cash flow and profitability in a bit more detail.
Cash flow has to do with the amount of money coming into your business as compared to the amount going out. Do I need to tell you that more inflow than outflow is a good thing?
Most small businesses, especially those experiencing rapid growth, need to track cash flow very carefully. Lack of cash is one of the leading reasons why small businesses go out of business.
To illustrate the concept, let’s use Marcy as an example. Marcy cans and sells organic produce as tomato sauce, pickled beets, and dill pickles. Following are the steps she follows to can tomato sauce:
- Purchase tomatoes, onions, and garlic (cash flow out – at time of purchase)
- Purchase jars, lids and other canning supplies (cash flow out – 30 day terms)
- 2 days in kitchen cleaning, canning, labeling hundreds of jars of tomato sauce (cash flow out – pays herself when she has the cash)
Marcy then takes the jars of tomato sauce along with her other products and sells them at farmers markets and health food stores. She does not receive any money until she sells them – frequently one at a time. (cash flow in – time of purchase)
Because tomatoes are only available in the summer, she purchases enough tomatoes in July and August to make tomato sauce to last for around 10 months. That means that she is paying for the produce and the jar supplies early on (cash flow going out), much sooner than she is selling the tomato sauce and receiving payment (cash flow coming in over the next 10 months.)
If Marcy is not tracking her cash flows, this delay in receiving cash can result in her being unable to pay for her jars when the 30 day terms are up. And if she stops paying, eventually the company will stop supplying her with jars, and she will not be able to can more produce which will hurt her business.
Over time, the cash flowing in should exceed the cash flowing out (see my next paragraph on profitability to see why I say should and not will). However, this delay can be fatal to an underfunded small business, especially if the small business owner is not tracking cash flow. That is why people say: “Cash flow is King.”
In order to combat the cash flow issue, it’s not unusual for someone like Marcy to think: “Cash is short, I will sell some of my tomato sauce at a discount to get cash sooner.”
Wait a minute Marcy! Don’t go down that road until you check your profitability.
There are two types of profit: gross profit, and net profit.
Gross profit is the most important, because if you are not making a sufficient gross profit, it’s impossible to have an adequate net profit. According to ExecuSpeak Dictionary, gross profit is the “sales revenue less the direct costs associated with creating what was sold. The profit that is available to cover other operating expenses.”
Net profit is your gross profit less those other operating expenses. And I know I don’t need to tell you that having revenues exceed all expenses is a pleasurable experience. I mean, isn’t the unlimited upside potential one of the reasons we do this?
When we look at Marcy’s tomato sauce here is the calculation:
Sales price of a jar of tomato sauce
Less Cost of the tomatoes, onions and garlic
Less Cost of the canning supplies
Less Cost of the electricity used (an easily overlooked direct cost)
Less Cost of Marcy’s time
Equals Gross profit on a jar of tomato sauce
Marcy should be able to calculate the exact amount of gross profit as a dollar amount or percentage of the sales price for every product she sells. If Marcy doesn’t calculate the gross profit, it is very easy for her to actually sell her tomato sauce for less than it costs for her to manufacture it (ie a loss) when she discounts it to turn cash.
Not only does Marcy want and need a gross profit, she wants one that is high enough to cover all the other expenses she incurs in running her business. These are things like her time spent selling, flyers and pamphlets to promote her company, the monthly phone bill, etc.
Once all of these other expenses are deducted from the gross profit, she is left with her net income, or net loss if she has sold her products too cheaply. And as a small business owner I am sure you can feel Marcy’s pain when she realizes at the end of the year she has worked 60 hours per week, schlepping heavy jars of food, only to see she has earned a few hundred dollars for her time.
That is why I say that my original question is a trick question. Cash flow is important. Without a positive cash flow, you will not be able to stay in business. However, profitability is just as important. Without profitability, well, you’d be better off donating your time to a charity or eating bonbons on the couch while watching reality TV.
Are you tracking your cash flow, anticipating all of the bills that flow cash out and when you will receive cash flowing in? And do you know your gross profit and whether it will cover all of your expenses so you experience your desired net income?
Have a great day!