On a recent Saturday, just before leaving for the office, I asked my son to buy a new hose so we could water the garden. When I came home a couple hours later, he and a friend were on their hands and knees applying duct tape to my new hose.
He said that when he turned on the water, it started leaking out of all the holes in the hose. When we looked close, we found that instead of the type of hose I wanted, he had purchased a soaker used to slowly water areas.Some small-business people, when they start up their new enterprise, think they are getting a hose. Instead they have created a soaker and all the money leaks out before it gets to the garden or bottom line.
Think of it this way. When money comes in to the business, usually through sales, it is like a faucet being turned on. Money or revenues then flow into the hose. We call this cash flow. How much water or money gets to the end of the hose depends on us. If we carefully plug up all those holes in our soaker, or at least control the size of them, money will come out the other end. We call that positive cash flow; however, if we are like many small businesses, we run out of water before it gets to the end of the hose, or month.
Sometimes, to keep the business alive, we need to put more money in the hose or business.
In hose talk, we call this phenomenon a siphon or vacuum. In business, we call it negative cash flow. This sucking action kills more businesses than any other thing I know, sucking up additional money from family, friends and savings instead of getting the money flowing in the right direction.
What we need to do is either increase the revenue stream or reduce the size of the leaks or expenses to just the right amount to match our cash flow or growth plans. To help get control of the leaks or expenses, we need to better understand each of them. The best way is to organize the expenses into specific categories and then number or code each category.
Then, as we write checks, each check is coded with the number of the appropriate expense category. When these expense categories are listed alphabetically, the list is called a chart of accounts.
Each month as the expenses are added up and subtracted from the revenue, the final number is called the bottom line. If it is a plus number, it's been a good month. If it is a negative number, we have had a loss, and we are in the red.
When we make this listing of our income and expenses, we have created a simple income statement or profit and loss statement. This can become a terrific management tool to understand our business better. It should become the basis for many important decisions which affect the well-being of our business venture.
Once we have several months of income statements, we can start to see patterns or trends.
Generally, one of the larger leaks that needs careful watching, especially as the business grows and becomes somewhat stable, is the cost of the products or services that you sell. This is called cost of goods sold. Other expenses or cash leaks that need constant monitoring and measurement are payroll, employee benefits, telephone, rent, insurance and entertainment.
This income statement is just one financial tool that you can create to keep your business healthy. The better you know these numbers and control expenses and cash flow, the more successful you should be.
By the way, you ought to keep a roll of duct tape around. It may not fix many expenses, but it sure can keep other things together.