"Never take your eyes off the cash flow because it's the lifeblood of business."
- Sir Richard Branson

TLDR (Too Long Didn't Read)

1. Profit and cashflow are both important but NOT the same.
2. Tracking solely profit while ignoring cashflow can actually lead you to bankruptcy.
3. You can very easily be profitable but lose cash every single month.
4. Even worse than that you'll end up paying taxes on profit that you don't have in the bank...
5. Scenario 1 is what you want, your revenue is paying all your expenses and then some and your bank is growing
6. Scenario 2 is a slippery slope, your revenue is not paying all your expenses and your bank is growing because you're taking loans
7. Scenario 3 is annoying, your revenue is paying all your expenses but your bank is not growing maybe because you're not collecting quickly or your have loans that you're struggling to pay
8. Scenario 4 is scary, your revenue is not paying all your expenses and you're bank account is shrinking every month

Ok so hopefully I didn't scare you too much, but everything I said can and has happened.

How do I know? Because I've seen it happen multiple times while working with small Canadian Business owners, I'm talking about restaurants, plumbers, coffee shops, electricians, agencies and many other industries.

This blog is for the new business owner or the soon to be business owner. In this blog we'll cover ONLY what you need to know about profit and cashflow, what they are, what they're not and the different profit and cashflows scenarios your business will need to navigate to be successful.

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Table of Contents

1. The Basics
    a. What is and isn't profit?
    b. What is and isn't cashflow?
    c. Putting it all together
2. The 4 Different Cashflow & Profit Scenarios
    a. Scenario 1 - The Goal: Cashflow Positive & Profitable
     b. What to do when you're in Scenario 1?
     c. Scenario 2 - The Calm Before the Storm: Cashflow Positive & Not Profitable
     d. What to do when you're in Scenario 2?
    c. Scenario 3 - The Storm: Cashflow Negative & Profitable
     d. What to do when you're in Scenario 3?
     e. Scenario 4 - The Nightmare: Cashflow Negative & Not Profitable
     d. What to do when you're in Scenario 4?

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The Basics

What is Profit & What it's Not

What is Profit

Profit in 1 sentence: is the revenue you're left with after all your expenses

Instead of saying: "my revenue after expenses was $10,000"  just say "my profit was $10,000"

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& What Profit is Not‍

It's NOT how much cash you have at the end of the month or year.

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What is CashFlow

Cashflow in 1 sentence: is the amount of cash your business collects and how much cash your business pays out.

Instead of saying: "My bank account grew by $5,000" just say "I'm $5,000 cashflow positive"

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& What Cashflow is Not

It's NOT how profitable your business is, you can be cashflow positive but your business might not be profitable or vice versa.

But HOW Alvie!? How does that make sense?

Ok bare with me. Here are some examples:

1. Revenue does not account for what you actually collected:
   ex: say you're a service based company that just sent an invoice for $10,000 that $10,000 will be recorded as revenue today on the books but does that mean you actually collected the $10,000 in your bank account? Nope. Maybe your client paid you a few days (or months, or years or never) later.
2. Expenses does not account for unpaid bills:
   ex: Say you received a bill from a supplier that says net 30 (in other words that means "pay me in 30 days") that bill is going to go into the expenses section of the profit and loss statement reducing your profit but it doesn't affect your cashflow because you didn't pay the bill yet
3. Loans that you've received does not affect your revenue:
   ex: Say your business just got a $50,000 loan, that's $50,000 cash inflow (not revenue) so in this scenario your cashflow will be up $50,000 but your profit is unaffected, in other words you could be unprofitable but your bank account can still grow if you find the right loans or financing (not a recommending spot to be in).
4. Loan payments aren't expenses (only the interest is an expense):
   Ok final ex: remember that $50,000 loan you took, well now you're paying it back $800/mo. That $800/mo is not an expense (it's just money someone gave you that you're giving back ie. borrowing) thats going to be $800 of cash outflow every month but once again has nothing to do with the profitability of your business

Now you have an understanding of the difference between cashflow and profit let's get into the 4 scenarios you'll need to navigate to run a successful business.

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The 4 Different Cashflow & Profit Scenarios

Scenario 1 - The Goal: Cashflow Positive & Profitable

This is exactly where you want and dream of being as a business owner:

• Your revenue is generating a good margin to cover all your fixed expenses
• You're paying down any loans the business may have
• AND your bank account is growing month over month

This is the best place to be, things to do when you're at this position:

1. Fill up your emergency fund with 3-6 months of expenses so if ever there's a rainy day you don't need to rely on loans or external financing to get you through the storm
2. After your emergency fund is filled, start investing in growth , growth comes in 2 forms:
   a. Investing in growing your revenue by 1. getting more customers or 2. making more from each customers through additional products or services
   b. Investing to "buy back your time" hiring admin and support staff to get you out of tasks and roles that don't help you as a business owner focus on what you're good at. This can be hiring your first virtual assistant or hiring a bookkeeper. Try to get rid of Anythings that you NEED to do but don't drive growth. You can get rid of them by delegating and documenting these processes.

NOTE: Before you make an investment think in terms of ROI (return on investment). Ie. How much MORE money will you make or save by spending that $15,000 on that new piece of equipment? Or How much time will you save by hiring that new person? 
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Example 1:  Buying a new equipment 
a. Costs you $10,000 (assuming no maintenance costs and will be functional for 10 years) will save your $100/mo ($1,200/year)
b. 12% return on investment
c. Not accounting for inflation you'll make your money back in about 8 years

Is that really worth it? Is that the area of your business that will generate the best return? These are all questions you can start to have with your partners and your accountant to ensure you make the best decision possible.

Example 2: Hiring that new employee

a. Will cost you $40,000 per year
b. After training will be able to save your 30 hours per week (1,500 hours)
c. Savings per hour: $40,000/1,500 per year = $26/hr
c. Are you able to take this new found time and bring in more than $26/hr? Or do you want to take a step back and value your you time at at least $26/hr?

Scenario 2 - The Calm Before The Storm: Cashflow Positive and Not Profitable

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You may not notice it immediately but being in this scenario will quickly bring you to Scenario 3 or Scenario 4 if you don't have a plan

• Your revenue is not generating a margin to cover your fixed expenses
• You're taking on loans to cover the expenses that your revenue cannot cover
• Your bank account is growing or staying the same because you're taking loans to keep things afloat

This is pretty risky place to be and you want to really get out of this as quickly as you can, here's what you do:

1. Step 1: Pull your Profit & Loss statement for the period in question
2. Step 2: Turn all your expenses into a % of revenue
3. Step 3: Search up the industry comparison P&L (you can google your NAICS code)‍
4. Step 4: Compare your gross margin with the comparison report
   Gross Margin Defined: Say you're selling a burger for $15, that's revenue, the cost of revenue is $1 for the bread, $0.5 for the lettuce, $2 for the patty, $0.1 for the ketchup total cost total cost of revenue is $3.6. Margin is the difference between your revenue and the cost of revenue in this case $15 - $3.6 = $11.5 (these numbers are also known as your unit economics)‍
5. Analysis on Step 4:
   a. IF your gross margin is HIGHER or the same as the industry then you know you're charging a really good prices for the the costs that you're incurring to make a sale
   b. IF your gross margin is LOWER than the industry you're either NOT charging enough OR you're paying too much for your raw materials/services, consider upping your prices or finding a cheaper materials/services
   NOTE on increasing prices: This could be a scary thing to do considering people don't like paying higher prices for anything but this can be a very strategic thing for your business let me explain: You're a barber that charges $50 per haircut and provide 100 haircuts per month, you're making $5,000/mo. Now let's say you increase the price to $70 but now include a wash pre and post haircut with premium shampoos and offer post hair styling, this might cost you 5-10% more in time but you're charging 40%. Now here's the crazy part you WILL lose clients BUT the thing is if you lose 30% of your client base you actually end up making the exact same amount as you were in 20-25% less time
   c. IF you notice your revenue is lower than what it needs to be then roll up your sleeves because this is where you'll need to find ways to grow your business without spending money because you can't afford it. To grow your revenue you can do 1 of 2 things. 1. Get more clients or 2. Make more per client. Our recommendation is to heavily focus on your existing clients and get them to refer other people to your business, you can incentivize this by providing special offers for referrals. We've seen add "add-ons" do better than "discounts" example, "bring a friend and get a free drink" does better than "bring a friend and get 5% off."‍
6. Step 5: Compare your operating expenses with with the comparison report‍
7. Analysis on Step 5:
   This will tell you how efficient your operations are in comparison to other businesses in Canada, highlight every category of expense that you have that is higher than your competitor, once you have it highlighted look at each category and see what you spent on for that category and find ways to minimize spending.‍
8. Step 6: Create a budget to make sure you're not going over on your fixed expenses‍
9. Step 7: Review your budget weekly to make sure everything is in check

Scenario 3 - The Storm: Negative Cashflow and Profitable

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This one is rough but not as bad as Scenario 2 or 4. Here's what this scenario means:

• Your revenue is generating a good margin to cover all your fixed expenses
• Your cash is decreasing month over month
• Either you're having a hard time collecting revenues quickly (or at all)
• OR you have a loan payment that's bringing your cashflow into the negative

Ok so at least your business is profitable, that's a good starting place. Scenario is 3 is bad because you can see that your business is profitable but your cash still decreases every month. You have plans for growth but don't have cash to do anything and worse of all you'll have to pay taxes on your profit at the end of the year but you won't have any cash to pay for it causing you to go into payment plans with the government putting a further strain on your business.

Here's what you do in this scenario: 

1. Step 1: Identify the problem, the problem can be 1 of 2 things:
   a. You're sending invoices but are struggling to collect from your clients
   b. You had taken a loan in the past that you can no longer service with your current cashflow
   NOTE: You can identify which problem you have by reviewing your cashflow statement
2. Step 2: If it's an accounts receivable issue here's what you can do:
   a. Improve your terms and conditions to include a fee for late payments. Now whether or not you actually charge this fee is up to you but this will disincentivize people from paying late in the first place.
   b. Never start the work until you've taken a deposit for at least all your upfront costs, if you need to hire a subcontractor or buy materials before starting a project make sure your deposit covers at least that otherwise you'll have to dip into your funds and risk not getting paid by your client.
   c. If a client is having a hard time paying you (say they're 30 days late on an invoice) introduce a payment plan, even if you're able to get 10% of the outstanding invoice per month that's better for your cashflow than nothing
   d. Invoice promptly and make sure the payment process is smooth. If you're thinking of saving the transaction fees on debit or credit card transactions I have bad news. You're saving the fees but spending more time on admin and increasing your risk of not collecting. Think about how busy your day to day is, your clients' days are just as busy and unfortunately paying your bill is not always top of mind. It's your duty as the business owner to not only remind the client of your outstanding invoice but to also make it extremely easy for them to pay you.
3. Step 3: If it's a loan payment problem here's what you can do:
   a. There's no way around this unfortunately it's either you pay back the loan by dipping into your personal expenses or you tighten the belt and reduce your expenses to create enough cashflow to pay back the loan
   b. If you're in a situation where you have multiple loans with multiple interest rates use the Avalanche Debt Repayment method to pay back your loan, essentially you start with the highest interest loan, pay that off first while making the minimum payments on all other loans then take whatever payment you were paying to the first loan and add it to the second loan

Scenario 4 - The Nightmare: Cashflow Negative & Not Profitable

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This is exactly where you DON'T want or have nightmares of being as a business owner. Your revenue is not paying for your expenses, you can't pay back your creditors and your business is losing cash month after month. You need to dip into your savings to keep the business alive or you're looking for loans but bad news no one feels confident in lending to you. This is the worst place to be and you should do everything in your power to get out of this position and never get into this situation again. You should stop thinking about any plans of expansion or growth and get your foundation down pact.

Here's what you need to do to get out of Scenario 4: 

1. Step 1: Solve 1 problem at a time, start with your profitability issue
2. Step 2: To fix your profitability read the steps in Scenario 2
3. Step 3: To fix your cashflow read the steps in Scenario 3
   IF you have creditors and suppliers that you won't be able to pay/haven't been able to pay keep reading.
4. Step 4: Communicate with your suppliers and creditors
   a. Preparation: Before initiating negotiations, it's important to have a clear understanding of your financial situation, including your income, expenses, assets, and liabilities. Gather all relevant documents, such as bills, statements, and proof of income.
   b. Contact the creditor: Reach out to your creditor, either by phone or in writing. It's often best to speak with someone who has the authority to make decisions about your account, such as a supervisor or manager in the collections or credit department
   c. Explain your situation: Clearly and honestly explain your financial difficulties and why you're unable to make the current payments. Be prepared to provide documentation to support your claims, if necessary.
   d. Make a proposal: Offer a realistic and reasonable plan to repay your debt. This may involve requesting a reduced interest rate, lower monthly payments, or a temporary forbearance period. Keep in mind that creditors are more likely to negotiate if they believe you are making a genuine effort to repay your debt.
   e. Stay calm and professional: Approach the negotiations with a respectful and cooperative attitude. Avoid getting emotional, as this may hinder the negotiation process.
   f. Be prepared to compromise: Creditors may not agree to all your requests, so be prepared to negotiate and find a middle ground that works for both parties.
   g. Get the agreement in writing: Once you've reached an agreement, request that the creditor provides the terms in writing. This will serve as a legal record of the agreement and help protect you in case of any disputes.
   h. Follow through: Stick to the agreed-upon terms and make payments as scheduled. This will help rebuild your credit score and maintain a good relationship with your creditor.
   i. Remember that negotiations with creditors may not always be successful, as they have no legal obligation to agree to your proposed terms. However, being proactive and presenting a well-thought-out plan can improve your chances of reaching a favorable agreement.

Thanks For Reading

Congrats on making it to the bottoms of this boring old accounting blog. I know everyone wants to be learning about marketing and sales and things that grow the business but the truth is when in business you need to learn the language of business or else you might find yourself in a bad situation. On the path to financial success there are a lot of pitfalls and booby traps, as you may have seen there are 4 scenarios and only 1 of them is good, which makes sense because in order to achieve the financial rewards we all desire we need to take risks. The issue arrises when you're taking risks without knowing what the risks are. Hopefully you found this blog informative and somewhat entertaining. If you liked the blog or hated the blog I'd like to know send me an email to to alvie@tallyaccounting.ca with your feedback.

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