Positive Cash Flow is the King of Business Success
The number of businesses that fail or never come close to their profit potential is shamefully high and almost always avoidable. Frankly, many business problems are caused by personal problems. If the business owner does a poor job of managing his or her money and time, then they will most likely make similar mistakes in their businesses. However, also contributing to the failures of most businesses is the fact that the vast majority of people, even highly educated ones, are uneducated concerning the foundational principles of business management.
When I say most people are uneducated about business principles, I don’t mean they haven’t heard of some of the principles — I mean they don’t really know how they work. More importantly, they don’t know how to apply them to their own businesses.
It is a lot like our knowledge of open-heart surgery. We have all heard of it, and we may have even seen it performed on TV; but that is about the extent of what we know. That doesn’t make us a heart surgeon any more than being able to throw around some business expressions makes us a business professional.
When a doctor performs open-heart surgery on a patient, there are fundamental principles he understands that must be used if he wants the procedure to be successful. Things like the critical rules of administering the anesthesia, principles of sterilization, pre-operation minimum health standards the patient must have met, just to name a few. The surgeon knows that breaking those basic laws of good surgical practice can literally kill his patient.
Similarly, if you break the laws of business, then the laws of business will break you. However, the opposite is also true. If you obey the laws of business, then small business ownership can also produce tremendous financial rewards.
A surgeon doesn’t get the luxury of insisting that every patient be the perfect candidate for surgery, or that the surgeon be totally rested before every surgery or always having his or her number one choice of anesthesiologist. In a like manner, it is not essential that all of the following principles of good business be used in every type of business in order for that business to succeed.
Fortunately, we have much more control over designing the ideal working environment for our business than a surgeon has over all the laws of good surgical practice. For example, the surgeon has virtually zero control over the general health of his surgical patient.
In business, we have a lot of control over the general health of our own business. The more of the key business principles we can engineer into our businesses, the higher the probability for success, and possibly even exceptional success.
There are six key principles of good business that I would like to focus on. My plan is to cover all six in this and future articles. However, this article is focused on the most important of those principles:
Principle #1: Positive Cash Flow
The lack of Positive Cash Flow is the #1 cause of business failure. Almost everyone knows that, but very few people know what it really means. Let me make sure you understand precisely what I mean by the term “Positive Cash Flow”. It doesn’t mean making a profit. It means that the income that comes in this month will be more than your expenses that you pay out this month.
Well… that sounds like profit, but it isn’t. This is an absolutely essential concept for any business owner to understand. Please read this one section several times if you find it necessary to grasp this concept. You could stay in business for years and make a good living without ever earning one dime of profit, but you must have positive cash flow.
In contrast, you could make good profits, but fail in business in less than a year because of negative cash flow. Let me demonstrate positive cash flow and profit so you can better understand how they impact business success and failure. Let’s suppose you spent $5,000 just to get started in a new business. Let’s further assume you borrowed all of the money from a “Visa” credit card.
If your required minimum payment to “Visa” is $200 each month, then you have a “Positive Cash Flow” just as soon as your business generates $201 each month. In this simple example, I am pretending that your only expense was the $200 payment to Visa for the $5,000 you borrowed, and that you don’t have other common expenses, like phone expense, etc.
Even though you have a positive cash flow of $1 for the month, you wouldn’t actually be profitable until you paid off the $5,000 credit card loan. Some of you might be thinking, “what if someone takes the $5,000 out of savings instead of borrowing”. The concept is the same, but the numbers would be different. You still won’t be profitable until you have paid yourself back the original $5,000 YOU loaned your business.
However, it would take less revenue or income from your business to produce a “Positive Cash Flow” if you didn’t have to borrow at high interest. If you could pull the money out of savings, you only have to make up for the interest you lost on your savings. This would usually be much less interest than you would have to cover by borrowing from a credit card.
In short, if you borrow money from your “Visa” card to invest in your business and the money produces even one penny over and above what you must pay to “visa” each month, then that is a positive cash flow. In contrast, if you invest the $5,000 in your business and it doesn’t bring in but $25 a month, then when you pay “Visa” $200 each month, you have to find the $175 shortfall from somewhere.
That shortfall is called “Negative Cash Flow” and it is the single largest destroyer of businesses, both new and old. Having a negative cash flow doesn’t mean you are “Losing” money. You can actually be making money and have a negative cash flow.
Let me demonstrate by comparing two new business owners who open identical businesses on the same day. Owner #1, we’ll call her Sally, borrows $5,000 from a bank for three years at very reasonable rates of interest. Sally’s business produces $175 revenue in her first month, so she is able to pay the bank the $160 payment on her loan and she has a positive cash flow of $15 for the month.
Note: Keep in mind that each month she pays the bank, she is actually reducing the $5,000 loan. At the end of 36 months, if everything remained exactly the same, she would have $175 a month positive cash flow. If she had no other expenses, having paid off the $5,000 loan, then she would also have $175 a month profit.
Let’s now consider Owner #2. Bob borrowed his money from a loan shark who charged 35% interest, instead of the 10% the bank charged Sally. Let’s assume that Bob actually produces more revenue than Sally. He has $200 revenue his first month. However, he has a negative cash flow of about $30 because he has to pay the loan shark $230 for the month.
Well, if Bob was in such bad shape financially that he had to borrow money from a loan shark just to start his business, then where is Bob going to get the $30 additional money to pay the loan shark? Obviously that is a simple and exaggerated example of the difference between positive and negative cash flow, but I hope you get the point. Positive Cash Flow is King. Without it, we will all fail in business.
Even though Bob’s business actually produced more revenue than Sally’s, he will actually fail while she succeeds. He won’t fail because he didn’t have a good business. He will fail because he paid such high interest that he didn’t gain the leverage that Sally got from her bank loan.
When people invest a few thousand or a few hundred dollars to start a new business, most of them realize it will take some time to pay that money back to themselves or to whoever they borrowed it from. However, the thing that many folks don’t anticipate is having to go for months with a negative cash flow.
The tragedy is that many people quit before they even had a chance to succeed, simply because they weren’t financially prepared and/or emotionally prepared to pay more money out than they were taking in, for several months or longer.