Entrepreneurs are expected to know the health of their business by reading the pulse of it daily, weekly, monthly, quarterly and yearly. Thereafter you compare yearly performances in order to ascertain better ways of improving your operations.
Your business as an entity is an “individual” like you. The life blood of your business is capital. Too much of it will hemorrhage your business to death through pilferage or cash losses, wastage or stock losses, mark down of prices because of inability to sell on time cum market price fall, and obsolescence. Inadequate capital can create coma in your business as well-a situation of having little and paying more. This way you are not able to take advantage of discounts on bulk buying, overdue debts not being paid on time, fines and penalties incurred for not making mandatory payments, etc. If you are like me, you need to understand or read the pulse of your business financials inside out (you must not necessarily be an accountant/expert or be very good with figures to do this) to be able to plug holes in whatever area(s) you deem important. This way your business will never go into coma or suffer high blood pressure as the case may be under your nose. If you can buy and sell you can x-ray your business too.
Now let's get down to brass tacks. Your business came about with a seed in the form of an idea. Usually this idea is seen as an intangible asset. It cannot be quantified immediately you commence business operations. Over time we can call this idea “goodwill” because it has gone from idea to a business with your reputation attached. Here people can believe and see what your business is and worth. The business can now be valued on the basis of Best Of Judgment (BOJ). It may be subjective but quite understandable.
The money you personally introduce into the business via savings to run it daily (i.e. working capital) or buy assets is treated as equity in the business. You may “borrow” from friends, relations, banking institutions, and so on to augment your equity contribution. This we will call “debt capital.” You will pay this debt at an agreed future date but not without a price to pay (i.e. cost of capital or interest). The lender's willingness and risk of lending you that money is the interest you have to bear. This is the opportunity cost of the lender not using that money elsewhere. That interest is simply an expense in your operations.
We will then translate the foregoing into a simple arithmetic:
(1.) EQUITY= ASSETS No Liability to Creditors or Lenders
(2.) EQUITY + DEBT= ASSETS Have Liability to Creditors or Lenders
From (1) above if your business fails (God forbid!) you are On Your Own (OYO). But with a good business plan from the outset and religious adherence to it you are sure to succeed. From (2) above you are not only responsible to yourself but to your lenders and creditors. You MUST not fail because the headache of having to explain to outsiders what went wrong will add insult to injury!
I am going to explain another important part of this article-Profitability and Cash flow. Profit is Revenues/Sales/Turnover(less returns) minus Cost of Sales. The profit here is because Sales is greater than Cost of Sales. Loss is possible and do arise. That is Sales is less than Cost of Sales using the above formula. Please you can always substitute either “Revenues” or “Turnover” where I have “Sales.”
PROFIT = SALES - COST OF SALES, sales > cost of sales
LOSS = SALES - COST OF SALES, sales
The above explanation is GROSS PROFIT/LOSS only. A step further will give you NET PROFIT. This is Gross Profit minus Expenses reasonably incurred in bringing in sales.
NET PROFIT = GROSS PROFIT - EXPENSES.
NET LOSS = GROSS LOSS + EXPENSES.
Mind you, “overhead expenses” will be added to “gross loss” to arrive at “Net Loss”. Your expenses simply increased your loss during a specified period. In computing Gross Profit/Loss many expense items are taken into consideration-those involving “cash” and “non-cash” items.
Cash Flow, on the other hand, determines how cash buoyant you are at any giventime-itis your liquidity level status. Cash flow is the movement of cash “in” and “out” of your business. It shows at any point in time how liquid your enterprise is. The importance of cash to the healthy growth or survival of your business should be taken seriously. This single factor can either make or mar your business. There are cases of business failures resulting from cash flow problems. This is also what is known as liquidity problem- i.e. no enough cash to do business when the need arises. Again the simple arithmetic for this is:
Beginning Cash Balance + Cash Inflow (Receipts) - Cash Outflows (Payments) = Ending Cash Balance
Therefore, there is no way the “Profit/Loss” of a business operation for a particular time period will always be the same as the “Cash Flow” of that same period. It is imperative to note that profit is actually a function of the judicious management of your business cash flow. The flow of cash- inflow and outflow- should be properly managed. The rule is: Cash Inflows should be accelerated while Cash Outflows should be decelerated when necessary.
In summary, if you understand why doctors examine and check their patients thoroughly, then you too need to examine your business operations in order to save its life! Always remember that your entrepreneurial, leadership and excellent skills will determine the level of your success and wealth in your business.
You Will Excel!
