Why You Should Monitor Operating Cash Flow and How to Do ItA SPECIAL REPORT FROM THE CREATORS OF SMART BUSINESS MONEY HABITS™

Cash flow. What is it? Search on the internet for the term

“cash flow” and you’ll find common agreement with Wikipedia that “Cash Flow is the movement of money into or out of a business”. As accurate as this definition may be, it’s not very helpful to the entrepreneur wrestling with a cash flow problem or working to avoid such problems.

Cash flow. What it’s not. Cash flow is not the same as

profit. It is not the same as cash in the bank. It is not necessarily a good measure of how well your business is doing. Having lots of cash flow does not necessarily mean you have lots of profit or even any profit. Alternatively, a high level of profit can be obtained while cash flow is weak or even non-existent.

Now let’s go back to that seemingly meaningless definition and flesh it out a bit….

“CASH FLOW IS THE MOVEMENT OF MONEY INTO OR OUT OF A BUSINESS”

A practical measure of a business’ cash flow is called “Operating Cash Flow” (OCF)

Also known as “Cash Flow from Operations,” OCF is a basic financial measure that tells us how well a business is really doing.

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Operating Cash Flow may be the single most important metric for measuring the health of your core business operations.

OCF tells you how much cash you generate from operating your business. It counts only the money coming from

customers. It excludes money coming from loans

or from your pocket. It deducts only the cash paid to

suppliers and for the general expenses of operating the business.

It excludes money going out for loan repayment as well as money used to reinvest for growth such as buying equipment or buildings.

The result shows whether operating your business creates cash (positive cash flow) or consumes cash (negative cash flow).

IF BASIC OPERATIONS ARE CONSUMING CASH, THAT IS A HUGE WARNING SIGN THAT YOUR BUSINESS IS ON DANGEROUS GROUND.

OCF is the source of funds to repay debt, buy needed equipment, and pay dividends or distributions to owners.

OCF MUST BE POSITIVE (CREATING CASH) IF YOUR BUSINESS IS TO SURVIVE.

How do we calculate OCF?

It may be as simple as printing an OCF statement from your computer accounting program. If your program is not set up to print an OCF statement, here is the formula to manually calculate OCF…

The Formula for Calculating Operating Cash Flow

Operating Cash Flow (OCF) = Net Incomeplus Depreciation & Amortizationplus decrease or minus increase in Accounts Receivableplus decrease or minus increase in Inventoryplus increase or minus decrease in Accounts Payableplus loss or minus gain from sale of assets

(It will take less than five minutes to take the numbers from your Income Statement (P&L) and Balance Sheet and insert them in the formula.)

Here are two real-life examples…

Company A Company BNet Income 254,000 254,000

plus Depreciation 14,000 14,000minus A/R increase 15,000 50,000

minus Inventory increase

3,000 20,000

plus A/P increase 12,000 2,000Operating Cash Flow 262,000 200,000

Company A is doing well.They generated OCF in excess of Net Income.

Company B has cause for concern.Although their OCF is positive, it is much less than Net Income.

From the increase in Accounts Receivable, it appears they may be growing too rapidly and consuming their cash.

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”Businesses often don’t go broke, they grow broke.

THIS MEANS THEY GROW FASTER THAN THEIR CASH FLOW CAN SUPPORT

Growing too fast is a common cause of cash flow crises and business failure.

Now that you know your OCF, what do you do about it?

As mentioned above, the first test is to see whether your business is creating or consuming cash.

If it is creating cash, the next step is to compare OCF with Net Income. Ideally, OCF is more than Net Income.

However, a growing business will often have OCF that is less than Net Income. This condition cannot exist for long before your business will be out of cash. Rapidly growing businesses must generally find sources of cash in addition to

OCF. The sources will be either loans, further investment of cash in the business by

the owner, or funds from investors.

But what about a business that is consuming cash?

THAT CONDITION MUST BE CORRECTED OR SURVIVAL IS UNLIKELY.

The Cash-Eating Business

You can begin the analysis process by studying the formula and each entry you inserted into the formula.

If you don’t find the source of the problem in that analysis, you must go to the Income Statement for the answer.

If solutions are not forthcoming, it is time to seek professional advice. Your accountant or one of the Smart Business Money Habits Advisors can provide the help you need.

For businesses in the startup or early operating stages…

…use Smart Business Money Habits #6: At the end of each week, project your cash on hand for the next 4 weeks and #7: Prepare a reliable action plan for dealing with projected cash shortages to begin the cash flow projection habit so necessary to business survival and success.

For businesses in more advanced operating stages…

…use the more sophisticated and focused Smart Business Money Habit #21: Implement an advanced system for tracking and managing your business finances including more detailed cash flow projections to gain control over operations and, most importantly, gain control over growth.

Tools for implementing these Habits are part of the Basic and Advanced More Profit Toolkits™.

FOR MORE DETAILS ABOUT THE MORE PROFIT TOOLKIT, GO TO:www.MoreProfitToolkit.com

How to Put More Profit in Your Pocket

You can also find additional information to actively use the Smart Business Money Habits to increase your profits in our eBook, How to Put More Profit in Your Pocket: Practical Principles for Building a Highly Profitable, Valuable, and Sustainable Business.

Learn more at: www.SmartBusinessMoneyHabits.com

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”If you don’t control your cash, you can’t control your business.

Don’t delay putting our Cash Flow Habits into practice if you want to create a profitable, valuable, and sustainable business.

About

Dan Bowser and George Huang are the founders of Business Money Insights (BMI) and creators of the Smart Business Money Habits and the More Profit Toolkit. BMI is an education and training company dedicated to helping independent business owners make and keep more profit from their businesses. Their mission is to help entrepreneurs become successful by introducing financial management and discipline to their businesses. You can learn more at: www.SmartBusinessMoneyHabits.com