Cash Flow Focus
Most people do not have the time or desire to read the different accounting statements necessary to manage their cash flow. Unfortunately, most entrepreneurs resort to “bank balance accounting”—checking their bank balance every day and making decisions based on their balance.
And in moments of financial distress, they might even break their own fiscal rules and spend money they don’t have. They’ll likely try to force themselves to become better at accounting and more “involved” in their cash-flow management to remedy this.
In cash-flow accounting, we're not trying to change your habits or how you’re wired. Not only is it nearly impossible to change financial habits, but your time is probably not best spent doing accounting (unless you’re an accountant).
Cash-flow accounting works with your existing habits and the natural flow of your business. By allocating compensation and operating expenses, you remove the temptation to “borrow” from your profit.
Theoretically, you should review and rely on many reports before making financial decisions. One of the most fundamental reports is the Income Statement (or Profit and Loss). This statement is based on a basic accounting principle:
The calculation “Revenue minus Expenses equals Profit” assumes that the profit is the runoff of the difference between revenue and expenses. It assumes you don’t know what profit will be, but you can control revenue and expenses in the calculation.
The cash-flow accounting model flips that around and says you should control your margins. This new calculation method assumes that you control the revenue and profit numbers dictating your expenses.
Cash-flow accounting teaches you that you should not focus on increasing revenue at the expense of your profit. Focusing on “more at all costs” puts many entrepreneurs in dire financial situations.
Keeping a tight rein on your expenses will be the most important factor in determining your ability to reach your cash-flow margin target. The crux of this idea is that you take a small percentage off the top line instead of the bottom line and that, by doing so, you’re creating a living margin.
This system works because it modifies your behavior and forces you to manage your cash flow differently. When you truly embrace the cash-flow accounting method and see the results, it will be worth it. The monthly, quarterly, and annual tasks will get easier over time, and, most importantly, your living margin will grow exponentially.