Planning Fundamentals 3: You Think in Profits, but You Live on Cash

(Note: This is part 3 of my planning fundamentals review. Here are the links to Part 1: Form Follows Function and Part 2: All Business Plans are Wrong.)

Cash flow is the most important mystery you have to solve. Cash flow is the real heartbeat of business. And unfortunately, cash flow isn’t intuitive. It’s tricky.

We think in profits. It’s part of our culture. Take the sales and subtract the costs and expenses, and if the result is positive, then hooray, we’re okay.

Unfortunately, it doesn’t always work out that way. Because of  accounting rules, sales are sales we made for this month, and costs are what it cost us to produce what we sold this month, and expenses are what we incurred this month. But — and here’s the brutal mystery and trickery of it — we might have paid those costs and expenses months ago; and we might not get paid for those sales until months from now.

So we can easily be profitable and broke. Not intuitive, but it happens a lot. Most product businesses need to spend on building or buying the product, plus packaging, assembly, and distribution, long before they can sell it. And most business-to-business sales involve waiting months to get paid.

If we could only get the research to prove it, we’d find that a surprising percentage of businesses that go under are profitable when they do.

Managing the cash flow, planning on cash flow ups and downs, is one of the fundamental purposes of good business planning. You lay things out in order: how long you wait to get paid, how early you have to build, debt repayments and capital purchases that don’t show up in profit and loss. And good planning helps you anticipate problems in time to deal with them. Go to a bank with a good history and a plan showing cash flow hills and valleys, weeks or months in advance, and the bank loves you. Try it on Tuesday because you’re going to miss payroll on Friday, and you’re out of luck.

For a good visual on the mysteries of cash flow, go to the free cash flow calculator at (shown in the illustration above) and use the sliders to watch what happens as you vary the wait to get paid and inventory assumptions, even without changing profitability. Watch how much faster the cash deficit grows when your sales grow fast and you don’t have an all-cash business.

You might also want to read my 10 critical rules for cash flow post. And just a could of weeks ago I saw a good collection of 6 Tips for Improving Your Cash Flow on the American Express OPEN Forum.


  • Planning Fundamentals 5: Planning Is To Manage Change says:

    […] Part one was Form Follows Function. Part two was All Business Plans are Wrong. Part three was Cash Not Profits. Part four was Planning as […]

  • Tyler says:

    Very true Tim, profits often lead cash considerably, especially in a newer, growing business. I have seen examples of businesses with sound concepts and growing revenue but that run into cash flow problems that force their owners to make unpleasant decisions. All of which could have been avoided with good planning (and great credit)!

  • John Krech says:

    Great reminder Tim and it is a hard thing to comprehend – profit is instantaneous and cash flow as you point out takes time. A good example is inventory. So many businesses fail to see the difference between turning inventory 3 times per year and turning inventory 28 times. It all gets back to when we pay for inventory and when we get paid for a sale. It is the same as adding months before getting paid. Getting to 28 turns is the tricky part – fortunately there are new small business technologies like Phitch that work with QuickBooks to make this easy.

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