Archive for September, 2009

Why cash and profit are different

September 24, 2009 by Joe Knight

As managers and business leaders we tend to focus our efforts on the income statement.  After all isn’t business all about being profitable?  The income statement measures profit so that should be our focus as we look at the success of our business.  If the bottom line of the income statement is positive then life is good.  If it is negative, then it’s time to find some outside investors.

Well what many managers and owners don’t understand is that the real key to being successful in business is having cash flow.  Cash is king.  A business fails when the cash runs out not when the company had losses on the income statement.  Cash flow is becoming a key measure on Wall Street right now.  Why?  Because investors and analysts know that in a liquidity crunch if a company can generate its own cash it will survive.  A second reason is that cash flow is not subject to as many estimates and assumptions as profit from the income statement.

So now the question how can cash and profit be that much different?  There are really three reasons why cash flow and profit do not match up well.

First, we book or record sales not when we collect on them but when the product or service is delivered.  This can lead to sales on the income statement that will not be collected for a great deal of time.  In most cases it can take 30-90 days to collect on those sales recorded this month on the income statement.  In the case of long-term contracts the recognition of the sale and the collection of the cash can be more than a year a part.

Second, we record expenses on the income statement when those expenses are incurred not paid in cash.  This is part of the accrual process.  The income statement is about matching expenses with sales.  So if I make payroll on September 1st, I do not charge that expense to September.  Rather, I charge it to August since the September 1st payroll is to cover work that was performed in August.  So we show an expense in August even though the cash did not go out until September.

Third, when I spend my cash to buy capital equipment for a business, things like computers, building, and vehicles, I depreciate them on the income statement as expenses over several years.  When I spend my cash on capital it’s gone.  On the other hand, the expense associated with this capital takes years to impact the income statement.

When one takes these three issues into account, it’s easy to see why cash and profit are two different things.  The message here for the financially intelligent business manger is to watch both cash and profit because understanding them is critical.  Why do most businesses fail?  Because they run out of cash.

Please share and like our post:
Share or like our post:

The Discipline of Market Leaders Updated with Some Caveats

September 10, 2009 by Brad

In the mid 1990’s I read a book that connected with me. It was The Discipline of Market Leaders authored by Michael Treacy and Fred Wiersema. In a nutshell it said that companies need to pick their marketing strategy from one of three choices, those choices are Operational Efficiency, Product Leadership, or Customer Intimacy. A company that believes they should do all three will fail.

 It goes like this:

  • Companies are most successful when they focus on only one marketing discipline
  • Companies are mediocre when they focus on two marketing disciplines
  • Companies will be run over when they think they can do all three

 

The table below summarizes the concepts of the book:

 

OPERATIONAL EFFICIENCY

PRODUCT LEADERSHIP

CUSTOMER INTIMACY

Core Business Process

Sharpen distribution systems and provide no-hassle service

 

Nurture ideas, translate them into products and market them skillfully

Provide solutions and help customers run their business

 

Structure

Strong central authority and a finite level of empowerment

Acts in an ad hoc. Organic loosely knit, and ever changing way

Pushes empowerment close to customer contact

 

Management Systems

Maintain standard operating procedures

 

Reward individuals’ innovative capacity and new product success

Measure the cost of providing service and of maintaining customer loyalty

Culture

Acts predictably and believes that “one size fits all”

Experiments and thinks “out of the box”

Flexible and thinks ” have it your way”

 

Company Examples

Wal-Mart – McDonalds

Intel – Nike – 3M

Nordstrom

Over the last few years I have heard nothing from these authors. I wondered are the concepts no longer valid, what has changed?

My feelings are they are as relevant today as they were 10 years ago, with two caveats.

First: it doesn’t matter what strategy you are pursuing, you need to continually look at ways to lower your costs and add more value (from the customers view not the companies) for lower costs. This is a fact in the world we live in today with no exceptions that I am aware of.

Second: adding more features and functions after a certain point where the customers aren’t demanding them will open up the possibilities of a disruptive product coming in and interrupting your strategy. This disruptive concept was originated in the book The Innovators Dilemma by Clayton M. Christensen, it is worth reading.

The Discipline of Market Leaders is still a relevant book today to help companies chart their path, but remember the two caveats.

Please share and like our post:
Share or like our post:

Let’s Talk Now 866-532-6856

Or fill out the form below and we will contact you.