COMPLEX CASH FLOW MODEL

As your business matures, you will likely need to move to a more complex cash flow model. The model I create for my clients still retains its simplicity of rolling up to limited lines of data, but it includes a more detailed forecast and presentation of the balance sheet and cash flow statement that most bankers and investors like to see. You can go to my website to download an example of this model (www.seeingbeyondnumbers.com).

There are two real advantages of the advanced model. First, you can look at data that covers a much longer period of time.

Second, you can do a rolling-twelve calculation for your P&L and calculate your key metrics. When you display the rolling-twelve data either graphically, as shown in exhibit 10.2, or as a grid of numbers, you can scan the numbers across time and see the real movement of the data.

hent size="4When you look at rolling-twelve data in a graph, you see some really interesting trends. I don’t much care about revenue growth; I care about gross profit growth. Sometimes I remove revenue from the graph if there’s a really low gross margin percentage, but if I can get it all on the same graph, it’s good to have both. So typically, I want to graph revenue and gross profit on a rolling twelve basis.

Exhibit 10.2 shows adjusted labor and adjusted pretax profit. A lot of the people I work with have historical data that’s distorted. Can you guess why? It’s because they haven’t been taking a market-based wage and they’ve been including distributions that really should have been salary. I do a calculation to show what the adjusted labor should be. Obviously, the adjusted labor creates adjusted pretax profit, and both appear in the graph. Adjusted pretax profit is the actual pretax profit minus the distributions that should have been taken out of the salary total because it should have been a salary expense. If you show $100,000 of profit but take $110,000 in distributions that should have been salary, you really had a $10,000 loss. That’s significant because it means your

Exhibit 10.2: Rolling-Twelve Graph

economic engine is broken. Your business needs to be able to pay you a market-based wage and still make a profit.

Another metric that’s critical to monitor is the salary cap. As you look across the graph, any time that the salary cap is below the adjusted labor line, you had a lack of profitability. As we’ve talked about in previous chapters, you have two choices: cut salaries to meet the salary cap or don’t spend additional money on salaries until your gross profit has increased. Usually, it’s a blend of the two.

Until your salary cap line is above the actual labor line, your business is underperforming.

The sooner people see changes happening, the better they understand the causes, and the faster they respond. A quick response makes it less likely that you’ll have a multiple-month decline. Otherwise, you’ll end up against the wall and have no choice but to change. You should make changes before you run out of resources, and that’s what these forecasts are designed to help you with. If your forecasts don’t prompt you to make changes before disaster strikes, you’ve wasted your time and effort.

In most businesses, there’s a significant disconnect between pretax profit and the actual cash flow. I use a full forecast model to help my clients evaluate their business strategy. The model is built around a full presentation of profit and loss, the projected balance sheet, and the projected cash flow statement (including both historical and forecast data) and a dashboard summary to recap key metrics, so it shows the relationship between pretax profit and actual cash flow. My staff can take a month of a client’s information and update this model in less than an hour. It looks complex, but we’ve found ways to make it very efficient and cost effective. We don’t want to spend so much time updating the model that we don’t have time to look at it and understand what the data is saying.

When the dashboard is complete, we csalplete, wean answer questions like: Where do you stand on profitability? How close are you to your sales targets? What are your operating expenses? How do you fare on your salary cap? How are your collections or DSO and receivables? Where are you in regard to your core capital target? Do you understand the tax implications of the profit?

Exhibit 10.3 is an example of the dashboard tab in the spreadsheet. It shows how we combine both data and comments because there are times when it is important to note when we see a troubling trend. We also use green (Great), yellow (OK), and red (Caution) to add visibility to the grading legend.

You can take a simple or a sophisticated, complex approach to your forecasting models. Either way, as you work more with your forecasting models, you’ll begin to create your road map to profitability.

Chapter 10 Keys

1. Use regularly updated forecasts instead of budgets. Budgets are a license to spend, forecasts are a license to make profit.

2. Keep your forecast at high level. Detailed forecasts do not encourage regular updating, and they’l take so much time to maintain that you won’t have time to evaluate them.

3. Evaluate your key metrics to understand the movement of your data.

4. Your forecast must connect your P&L to your balance sheet. Keep your eye on how your cash lags your profitability.

5. Rol ing-twelve data gives you the best sense of mega trends in the business. The sooner you detect a change, the sooner you can fix it.

SUMMARY