If you work in technology like me, you may not think there’s a need to focus much on finance. It is important though to understand the numbers, especially in project management. In my next several blog posts I’m going to focus on financial management. To begin, let’s start with the green hard stuff, cash.
When it comes to cash and business, there are three things to know. The first is that cash is not the same as profit. The second is that most companies fail due to a shortage of cash flow. The third is that the cash statement provides valuable insight into a company’s situation. That last point is particularly important if you are planning to buy stock in a company. Warren Buffet might be the world’s greatest investor because he understands cash.
Cash is not the same as profit
Profit is the amount of revenue generated minus all expenses, what you have left is profit. So what is the difference between cash and profit? First cash doesn’t reflect money coming in through earned operating income. The cash may be coming in through loans or investors and that money doesn’t show up on an income statement.
Money from recorded profits isn’t received until some time after the transaction takes place. In an all cash transactions the funds will placed directly into the sellers account. Small companies that are growing and creating profit, but not receiving the cash needed to keep up with expenses, run into trouble. This leads to the next topic which is that most companies fail due to a shortage of cash flow.
Most companies fail due to a shortage of cash flow
Profitable companies can go out of business if they don’t have enough cash. What happens is that they are continually waiting to receive cash to keep up with their expenses. An example would be as follows: Company A is a startup which over its first several months of business has recorded good revenue gains and large profits. The transactions for the products the company sells take 4-6 weeks for the funds to arrive. Due to the delay in receiving payments, the company does not have enough cash in the bank to cover the costs of operating expenses and growth. This ends up being a continual game of catch up with the actual cash behind the recorded profit. For most companies and startups it won’t be sustainable.
By reviewing a cash statement you can gain valuable insight into a company’s situation and where it might be headed
Income statements are complex and can be deceptive. The numbers can be manipulated by accountants to appear as though company is in better shape than it actually is. Most of the expenses on the statement haven’t been paid during the time of the statement.
Cash statements give an accurate view of how much cash was received and paid within a certain period. The cash flow statement can not be altered by the accountants like the income statement can be. Due to this, the cash statement gives great insights to investors because it paints a clear picture of how the company is doing.
In a sense the cash flow statement is a way of looking into a company’s bank account. The cash flow statement can provide valuable insight into a company’s future. If investment money is coming in, that may be an optimistic sign for the future. It could also mean that the company is selling stock to stay afloat. Looking at the cash flow statement may generate questions, but they are the right ones to be asking.
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