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That day when somebody asks ‘Who stole the cash flow?’

“The importance of knowing accounting cannot be underestimated; it’s the language of business. If you don’t know it, it’s like being in a foreign country without knowing the language.”

– Warren Buffett, CEO, Berkshire Hathaway Inc.

“We’re broke,” Tom mumbled to himself. Tom Sampson is the controller of Ace Business Stuff and was reviewing his latest calculations on their cash flow.

“What do you mean, we’re broke?” Tom looked up sheepishly to see John Wilson standing in his doorway. He fingered his collar and turned to address the company’s CEO. “We can’t be broke because business has never been better,” John said. “Our sales are up over 20 percent, and we’ve even knocked a few percentage points from our costs so our margins are up, too. Our operating expenses are about where we expected, so we should be hitting the ball out of the park.”

“You’re right about our profits, John. We’re on our way to our best year. We’re just out of cash.”

“How can that be, Tom? We just agreed that we’ve having a record year.”

“John, we’ve discussed this before. Profits aren’t the same as cash. Profits are the excess of revenues over costs, measured when we deliver our products. Cash flow is the excess of what we collect from those sales, less what we use to run our business. They don’t always occur at the same time ... or the right time.”

This conversation, in many forms, takes place every day in conference rooms and hallways across America. You may have been in a few. Business is growing; the company is investing in people as well as property and equipment. It’s expanding operations, adding product lines and serving customers. Business is prospering ... but there is a limited understanding of the accounting and cash-flow implications of its plans.

“Didn’t you see this coming, Tom? You said we’re on top of the bank stuff and our accounts are clean. Why didn’t we see this sooner?”

“John, we’re lucky we’re even seeing it now. It was only when I saw our receivables climbing faster than our revenue that I knew something was off. It was Jody who told me that the salesmen got approval to extend our payment terms from N/30 days to N/60 days.”

“We had to do that, Tom. Our customers have expanded their purchases from us because we’re able to offer more generous terms than our competitors. That’s what’s fueling our growth.”

“Which is exactly why we’re out of cash, John. We’ve got all of these extra sales, but we haven’t collected any cash from them yet because we’ve given the customers longer to pay. Nobody told me or our purchasing manager, so we didn’t have a chance to reach a similar deal with our own vendors. So, we’re stuck with having to pay them on time. Plus with the people we’ve added, our payroll is up, and we have to pay that every two weeks no matter what.”

What the CEO is painfully discovering in this simplified example is that the flow of profits and the flow of cash are asynchronous – that is, they don’t follow the same pattern. This kind of accelerated growth that ranges at or above 15 to 20 percent per year is what I call the “Big River,” and the bigger the river, the greater its impact on everything around it. It’s indiscriminate as it absorbs the cash faster than the profits can keep up.

You’ll remember that last column when we said we would be examining the key variables that drive the most important business decisions. In the conversation between Tom and John, the Big River is consuming all of the company’s liquid assets. It’s the growth rate that is the engine that drives so many of the issues we identified. Dilution. Leverage. Valuation. Liquidity ... and more.

“It’s not as bad as all that, John. I think we’ve got a good story to take to the bank to discuss some inventory and receivable financing. We’ve got solid receivables and inventory, so we should be able to borrow enough working capital to get through this period, collect our receivables and better align our terms with our vendors and our customers. You were right – this is a good time to call our bank.”

•••

Lary Kirchenbauer is the president of Exkalibur Advisors Inc., providing practical business strategies for family and other privately owned businesses in the middle market. He works closely with senior executives and their businesses to accelerate their growth and improve personal and professional performance. He can be reached at 415-602-7870 or lary@exkalibur.com. His Web site may be found at www.exkalibur

.com.