Understanding Money in a Business
By ActionCOACH Mark McNulty
When I talk to business owners about finances, the vast majority never talk about anything other than their revenues, or sales figures. The same goes with goal setting, most prefer to focus on sales/revenue targets. While obviously revenues/sales are important, that is only one form of the money in your business. If your business is going to provide long-term financial benefits for you, the owner(s) (and if not, why are you going through the stress of owning a business), then you need to understand all four forms that money takes in your business.
Money in a business takes on four distinct forms – Revenue, Profit, Cashflow, and Equity. Let’s take a look at how each of these forms, and how they fit into your business.
Revenue is the first form of money in your business, and it is created by your employees. The primary job of your employees (including when you are wearing your employee hat) is to generate revenues by performing work to create or sell products and services. Revenues are easy to track and to establish measurable goals. Too many business owners stop thinking about money after setting their Revenue goals.
Profit is the second form of money in a business, and comes in two forms – gross profit and net profit. Profit is what is left over after expenses, first Cost of Goods expenses (leaving gross profit) which is then used to pay Overhead expenses leaving net profit. It is the job of management to plan for and create Profit in a business. This is one of the least planned for results in a business, yet it is probably the most important for the long term health of a business. Every business should be focused on maximizing the amount of profit it generates, as without it the business cannot continue to grow and achieve its mission, whatever that might be.
Cashflow is the third form of business money, and can be simple in some businesses and extremely complex in others. Cashflow is exactly what it sounds like – how money flows through the business. Cash comes into a business when products and services are sold, creating Revenue, which is used to pay the business expenses, with the leftover cash (Profit) then used to buy/create more products to sell. Different businesses/industries have different cycles of Cashflow, depending on how long you are given to pay your suppliers and how long your customers take to pay you. Owners are responsible for planning and managing the Cashflow of a business, taking into account the timing of both the inflows and the outflows, ensuring that there is always sufficient cash available to sustain operations and growth.
The fourth and final form of money in a business is Equity. Equity represents the actual dollar value of the business, and is the responsibility of the owner wearing her Investor hat. In addition to paying the bills and providing yourself with an income, you need to be thinking like an investor, building Equity in your business so that your business has value when the time comes to retire. Studies show that the vast majority of owners of closely-held businesses do not have adequate savings to retire, so they need to build the Equity in their business in order to be able to sell it for a sufficient amount to pay for your beach retirement house.
When planning for 2015, I want you to set goals for both Revenues and Profits, make sure you have a firm grasp on the timing and adequacy of your Cashflow, and that you have at least 3 strategies in place to increase your Equity in your business. Do this every year and you will grow in a sustainable, lower stress manner than you ever thought possible, and when it comes time to move to your beachfront retirement home, you will be able to pay for it with the value you built into your business. Have fun!