This Is Why You’re Profitable But Still Struggling with Cash

Most small businesses fail because they run out of cash. So I'm going to show you how to convert your revenue, all the money that's coming in from selling your products and services into cashflow. Let's go ahead and jump in and start with the income statement.

So the income statement will show you how much money you're earning from selling your products and services and running your business. In other words, it's your profit and loss statement. So on the income statement, we begin with revenue. This is your top line. Now, a lot of companies think that if they're in a cashflow crisis, if they just go out there and sell more, it will fix the problem. But if you don't fix what I'm about to show you, everything below revenue, then it can just exacerbate the problem. It could just make it 10 times worse.

So revenue represents the amount of money you earn from selling your products and services. It's your top line. Underneath revenue, we have COGS, which stands for cost of goods sold. It's all the costs associated with putting in place your revenue, with delivering your products or services into the hands of your customers. If you take revenue minus cost of goods sold, you arrive at gross profit. Forget my handwriting here. It can be terrible sometimes.

All right. So we have revenue, cost of goods sold and gross profit. Gross profit is helpful because it will tell you, are you making money by pricing your services and products at a certain amount and selling them at a particular volume and then incurring costs in order to fulfill your revenue? All right. So it tells you how much profit you're earning before accounting for overhead, which is next.

So we have revenue, cost of goods sold, gross profit. Underneath gross profit, we have operating expenses. Now, operating expenses can be broken down into selling and marketing, cost, research and development. I'll just abbreviate here. And general and administrative.

All right. So these three categories make up your OPEX, your operating expenses. All right. So if we take gross profit, minus selling and marketing expenses, minus research and development costs and general administrative costs as well, we arrive at operating profit. Okay. We're not done yet because we also have to account for interest cost and taxes, and this will give us net income.

Now this is where most business owners stop. They look at the income statement and they'll look at the top line. Typically they'll evaluate some of the costs in between, but then they narrow in on net income. And as long as net income is positive, they think all is well. But did you know that 70% of companies that go bankrupt are actually profitable when they close their doors? Yep. You heard me say that right. They actually have net income. They have positive net income, but they go bust because they run out of cashflow. And that's what I want to get into next.

So we have the income statement here, and then we're going to get into, and I'll save a little bit of room, the statement of cash flows. All right. That's what we'll dive into now. And the statement of cash flows begins with net incomes. So you take the net income number off the income statement, and that's where we begin with on the statement of cash flows. And that's how the two financial statements tie together.

Now underneath net income, we have to account for non-cash items, such as depreciation and amortization on equipment or on intangibles, or the gain or loss on a sale of a piece of equipment, because these are just accounting items and they're not true cash items. So we have to account for those. And then also we have to account for changes in working capital. I'm just going to put a little triangle here to represent changes in working capital. And when we add all of these three things together, we get cash from operations.

All right. Now, working capital is essentially the difference between current assets and current liabilities. These changes that show up on the statement of cash flows, they come from the balance sheet by comparing one period over another period. For example, you may have accounts receivable. In other words, the amount of money that your customers owe you with a balance of a hundred dollars at the beginning of one period. And then at the end of the following period, it may be $200. So therefore accounts receivable went up by $100 from 100 to 200. And so that's the change in working capital that we're talking about. It's a hundred dollars, but you also have to account for the change in inventory and the change in prepaids and the change in accounts payable, et cetera.

So you're going to look at all of your changes in your current assets and your current liabilities. And that's reflected right here in working capital. And like I said, that's coming in from the balance sheet. Next, if you look under cash from investing activities, you will find cap X, which is just short for capital expenditures. It's essentially the amount of cash that goes out the door.

When you buy trucks, trailers, tractors, a building, et cetera, to run your business, all your property plan equipment, in other words. So we have cap X right here. And then if you take cash from operations or operating activities and you subtract out your cap X, you arrive at free cashflow.

Now, when I'm evaluating a business and I'm looking at their free cashflow, I like to just break it down into four main areas, because these are the four main areas that I can actually influence. So if we look at gross profit right here, this is going to be the first area of influence. And this is your gross margin.

Oops, I can't even spell here. That is terrible. Okay. That says gross margin if you can't read it. Now, gross margin can be influenced in three different ways. Let me just get another color here first through pricing. So in other words, you can increase the prices of your products and services by strengthening your offer, making it more compelling, increasing the perceived value that you're selling to your customers, or you can do more volume.

In other words, sell more units. So you have pricing and volume that impacts your revenue, or you can decrease your cost of goods sold. In other words, you can renegotiate with your suppliers to get a better price on your materials, or you can make your labor more efficient by investing in better equipment, reducing friction out in the field, better training, better SOPs, technology, et cetera, to drive this down because materials and your labor costs are going to be the two biggest factors of cost of goods sold. Or you may use subcontractors. And if you're buying out subcontractors, there are some strategies there as well, but those are the main things that are influencing your cost of goods sold.

All right. These three things together, these levers right here, impact your gross margin, right? Now we have the second lever, which is your operating margin. And there's one thing you could do here, which is control your operating expenses.

This involves just simplifying your business. It's reorganizing your company and making sure you have a really tight cost structure. And what this means is that if you look at your op-ex, probably the biggest cost in your business is your labor. So it's making your labor more efficient. A lot of companies will just create an org chart when they're going through this process and they're like, okay, who do we have in which boxes? And how do we just shuffle people around?

When I look at overhead expenses, I say to the owners, I say, imagine we blow up the company, we fire everybody. And there's a gasp. They're like, you know, Steve's going to fire everybody. I'm like, okay, hold on. We're not going to fire everybody. But what I'm saying is, let's say your business has $3 million in op-ex. Imagine you just lay everybody off. You fire everybody, you blow up the company. And then I say, here's $3 million. Go out there and take that $3 million, invest it in selling and marketing, research and development, and your general administrative costs to support all this, but do it in the most cost effective way. Can you do it? And can you do it for two and a half instead of three? Or can you do it for two?

And when you start thinking from a zero base perspective, rather than from what you already have, that's when you're going to start to optimize your business. All right? So this is another thing you could pull another lever in your business to drive better performance. All right. So the next thing you'll want to pay attention to is working capital.

All right. Now working capital is going to come from all this, your net income, your non-cash items, and your changes in working capital makes up your working capital. Now the three big levers to pull are going to be your accounts receivable. In other words, how fast do you get paid from your customers and how well you manage that your inventory and how fast you're able to turn that and not over invest in that and your accounts payable, which is how much money you owe your vendors and how you pay your vendors.

All right. So these are the three main levers right here that you can pull to influence working capital. And then the last piece of this is going to be your cap X. Now remember, this is just your investment in property plant equipment.

So when you're buying trucks, trailers, equipment, right? To run your business, what you're going to want to do is number one, have a strategy where you can figure out how do you earn revenue with the least amount of capital as possible, because high capital intensity businesses, they just drain your cashflow.

All right. So if you are in a business and it requires a lot of trucks and a lot of trailers and a lot of, you know, manufacturing equipment or a big building or a big warehouse, whatever it is, figuring out how can you put in place a strategy, right? So maybe you're outsourcing some of your production, or maybe you're going up the supply chain. Maybe you're getting into more design, right? And you're selling imagination rather than production, right?

Design and imagination is going to be the highest level of value in the whole process. So if you can change your strategy, if you can change the way that you deliver your outcomes and your solutions to your customers with less capital, that's going to be the key. Also, you don't want to over-invest in your cap X. I see a lot of companies out there. They'll buy super fancy trucks with the bling bling with the chrome, with the chrome rims, maybe some spinners, some feather interior, you know, tinted windows, all the bells and whistles. And I'm like, why are you over-investing in company trucks? Just invest in basic trucks to get the job done.

So this is what you're going to want to control here is your cap X investment and just your capital intensity. So there you go. This is how cashflow breaks down in a business. And if you can understand this, especially how the income statement and the statement of cash flows works together. And even, you know, if you're going the long way, how numbers from the balance sheet come over to influence free cashflow at the end of the day, you'll be so much more successful.

Remember free cashflow is the amount of cash that's left over after everything is said and done. And it allows you to pay yourself or pay back investors, pay down your debt or reinvest in your business. Free cashflow is the lifeblood of every single business. And you have to understand this as a leader, because if you don't, you're going to be making a lot of mistakes like I did early on.

In fact, I wrote this book. It's called cashflow. It's for non-financial people right now, as of the recording of this video, you can get it for free by going to coltor.com. I just ask that you pay for shipping. If you live in the continental U S and I'll pay for the book and everything else, right? Because I want to get this in your hands. So you understand what are the levers of cashflow, because that's why the majority of companies go bust. And I don't want that to happen to you. And even if you're sitting on a lot of cash, things can change in an instant. And all of a sudden you can find yourself in a cash crisis.

All right. That's what I have for you. If you ever want to talk through this, if you want to hop on a strategy call, we offer that for free. You can do that at coltor.com. It's 20 minutes. And we'll talk about your business and see if there's a fit for us working together. All right. Until next time, take care of yourself. Cheers.