Revealed: Two More Of The Five Financial Mysteries

This is the second of three articles on how to prevent your firm from becoming part of the increasing mortality statistics of U.S. small businesses. That’s right. The SBA reports that 50% of small businesses fail in the first four years, instead of five years, as they reported 20 years ago.

In this series, I’m revealing what I call the Five Financial Mysteries. Actually, they shouldn’t be mysteries at all – they’ve been around for generations. But with this much Main Street carnage – a 20% increase in startup failures – it’s obvious that a lot of people haven’t learned what you must be able to do to sustain your business: operational financial management.

If you think you’re an excellent financial manager, then you won’t find any mysteries here. But if you could use a little help with your financial management, then this series could be just what you need. Don’t worry, we won’t get too mathy.

In the previous column, the First Financial Mystery was revealed: Cash and accounting are not the same thing. Today you’re going to discover the Second and Third Financial Mysteries.

Financial Mystery Number Two: You can be profitable but not have positive cash flow.

Here’s what this looks like: If you pay suppliers before customers pay you, your company may be profitable but someone else has your cash. Here’s what this sounds like:

Receptionist: “Boss, your banker’s on the phone, something about being overdrawn.”

You (to yourself): “That can’t be. The bottom line on my financial statement shows we’re making money.”

This is like the “Blondie” cartoon where she couldn’t understand how she could be out of money when there were still checks left. You look good on paper, but you’re still out of cash. The profit you derived from customer purchases was “accounted” for and presented on your financial statements, but the actual cash receipt for that purchase may not happen (likely not happen) until after the current accounting period.

You can’t spend the profit on the bottom line of your Operating Statement (aka P&L, or Income Statement). By the same logic, posting a periodic loss doesn’t mean you’re out of cash.

By the way, your banker’s still on hold.

Financial Mystery Number Three: Cash-on-hand isn’t profit you can spend.

Here’s what this looks like: When you’re on an open account (net 30) relationship with vendors but customers pay you at or near the point of sale, you will often have temporary positive cash flow that can be misleading. Here’s what this sounds like:

You: “Man, this is great. I’ve never seen so much cash. Darlene, I’m going down to the dealership to pick out my new truck. And when the guys bring that new fixture, go ahead and write the check.”

Darlene: “Hold up there, cowboy. I just totaled the vendor invoices (payables) for all of the stuff we sold this month. You might want to see this before you trade up to the King Cab.”

You: “@!#*, this total is more than my cash! What’s going on here?!”

In the twinkling of an eye, your new pickup just got T-boned by Financial Mystery Number Three.

This Mystery is probably the biggest reason point-of-sale businesses fail (retail, restaurants, etc.). How often have you seen a restaurant open and close within 90 days when the food and service were good? They probably thought their cash was profit and spent it.

There’s a reason most start-up companies begin their relationship on a C.O.D. basis with vendors. If you don’t understand Mystery Number Three, you might want to put yourself on C.O.D. until you do.

This will be on the test: No legitimate business can out-profit bad cash management.

Write this on a rock … Your checkbook won’t tell you about profit, and your P&L won’t tell you about cash.

Next week: Financial Mysteries Four and Five

Jim Blasingame is the author of The 3rd Ingredient, the Journey of Analog Ethics into the World of Digital Fear and Greed.