Five Financial Mysteries Revealed, Part III

Jim Blasingame

This is the last of a three-part series covering what I call The Five Financial Mysteries. In the first two articles, the first three Mysteries were revealed about the relationship between cash, accounting, and profit. 

In this article, I’ll complete my attempt to help you stay on the right side of the business survival/failure statistics. So, buckle up as I reveal Financial Mysteries Four and Five.

Financial Mystery Number Four

You can get squeezed between vendors and customers.

Vendors and customers are the prime entities every business deals with financially every day the business is open. Understanding your relationship between these two, (literally between, because your business is in the middle), is the key to cash flow management. The way to avoid getting squeezed is by managing your Accounts Receivable (A/R) Days and Accounts Payable (A/P) Days. Mathy warning: This will get a little mathy, but it isn’t difficult IF you have current records, plus, you don’t have a choice.

A/R Days is the time it takes you to collect cash for sales you made on credit. Divide the A/R total on your balance sheet (you do have a current balance sheet, right?) by total sales revenue from your P&L for the same period (you do have a current P&L, right?) then multiply that quotient by 365.

Example: Accounts Receivable $80,000 ÷ $750,000 Revenue = .1067 X .365 = 38.9 Days Receivable. You took an average of 38.9 days to collect your receivables. 

Next, A/P Days – the time you take to pay vendors for purchases. Divide the A/P number on your balance sheet into your cost of goods sold (COGS) for the same period from the P&L, then divide that quotient into 365.

Example: COGS are $450,000 ÷ $35,000 Accounts Payable = 12.86. Then 365 days ÷ 12.86 = 28.4 Days Payable. On average, you paid vendors within 28.4 days.

The relationship between your A/R Days of 38.9 and A/P Days of 28.4 shows that, on average you paid vendors 10.5 days faster than customers paid you. That means, without any cash from other sources, you will experience negative cash for over 10 days. 

And remember, your company could very well be profitable and growing. But for a third of a month, you will be out of cash, unless you rely on credit or have working capital from retained earnings (profits you didn’t spend).

Now that this mystery is revealed, you can manage A/R Days and A/P Days closer together and make this cash shortfall essentially go away. For example: Wait four days longer to pay vendors while getting customers to pay four days earlier, and cover the other two with organic capital – retained earnings. 

Financial Mystery Number Five

Profit is the Queen of Business, but Cash is the Emperor.

Does this sound like having cash is more important than making a profit? Well, it is. Sort of. Sometimes.

Profitability is the nutrition your business must have to become strong and muscular. Cash is the oxygen your business breathes. You can work through periods of unprofitability that befall almost every venture – especially in the early days. But even a profitable business will be out of business in a few days if it runs out of cash. 

The velocity of cash leaving your business will take your breath away. The most intense, anxious, and anguishing moments of your career as a small business owner won’t be when you don’t make a profit, it will be when you are out of cash. Manage your business for profitability but operate it for cash flow. Not either/or – both/and.

Now that the Five Financial Mysteries have been revealed, you should have a better handle on the relationship between cash, profit, accounting, and the impact of time on all financial management. And you should be able to join that other business statistic: millions of successful, profitable, sustainable small businesses.

Write this on a rock ... Let’s rope all Five Financial Mysteries into one short, handy sentence: Buy low – sell high – keep track.

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

Print page