There is an easy way and a hard way to explain what cash flow is – the easiest way that I know is to help you create a visual in your mind of what cash flow looks like. Cash essentially flows in and out of your bank account over a period of time, much like this circle below. 

Money coming in is of course very straightforward... it’s the money going out that I want you to pay particular attention to.  When I say Money Out it can included two things:

• Money that is gone (has actually left) and
• Money that is technically trapped – meaning, it’s still stuck in your business and thus can be unlocked and put into your bank account

Knowing that money is trapped and can be unlocked is extremely powerful because you now know where you need to focus your attention.

Unlike profit, cash position estimates (or forecasts), cash flow is 100% certain – there is no ambiguity or doubt.

If you calculate it correctly, you will know how much money went in to your business during a period of time, how much went out, and WHERE cash got trapped.

And this is why it doesn’t make sense to waste a lot of time on cash flow forecasting – at best it is only a guess about where you might be in the future – if you rely solely on a forecast, you are likely to waste time, overlook stuff that is really critical, AND you will not have enough time left over to fix the problems that created poor cash flow in the first place.

Cash flow should never be confused with profit, your bank balance or an estimate of your cash position in the future. Cash and profit are components of cash flow but they are not the whole picture.  If you only look at profit or your bank balance, you will miss at least 60% of the overall picture of what happened to your cash flow and why.

Cash flow tracks the movement of cash through your business as it operates.  The most important thing to remember is that cash flow is certain – it’s the net difference between cash inflows and outflows over a period of time.

A cash forecast (also known as a cash position estimate) is a best guess about what might happen.  Many people attempt to do this using an excel spreadsheet – unfortunately, these are usually not complete or accurate enough to forecast your cash position with a high degree of accuracy. These forecasts are also often not objective and they rarely help you pinpoint the best places to unlock cash quickly (or give you the strategies that you need to do it effectively).

A Highly Visual Example of Cash Flow

I want to give you a simple example that will help you to keep the difference between cash, cash position estimate (or cash forecast), and cash flow straight in your mind...

Imagine you are a farmer and the land where you farm is in a drought.  It hasn’t rained in weeks and you are starting to get worried that you might lose your entire crop.  Now I have an important question for all of you...

Is it more valuable to know:

• where an underground well is on your land and how much water is in it OR
• that there is no rain in your rain gauge hanging outside your kitchen window OR
• that the Farmer’s Almanac says it should rain 20cm sometime this month? 

The answer to my question is pretty obvious, isn’t it?

Cash flow is a certainty which is why knowing how much cash is trapped in your business (so you can unlock it and put it in your bank account) should be your #1 focus. 

Cash flow is very similar to my analogy about finding and tapping into an underground well of water to irrigate your crop.  Cash flow analysis is the equivalent to finding, measuring, and tapping into that well. Whereas cash (i.e your bank balance) is more akin to seeing how much water you have on the ground (or in your rain gauge) right now and a cash position estimate (or forecast) is pretty similar to trying to consult the Farmer’s Almanac to predict when it might rain.  At best, the Almanac is just a guess about what might happen sometime in the future.

Penny and Ernest

When you look at your Profit and Loss and Balance Sheet, essentially what you are looking at is a summary of:

• All the money that was collected and WILL BE collected in the future (even though there is no certainty about the timings of those collections) and
• All the money that was spent and WILL BE spent in the future ((even though there is no certainty about the timings of those outgoings)

Financial statements in many ways are like a running total of EVERYTHING that has happened and a lot of stuff that has yet to happen.

Cash flow is a completely different beast.  It is a certainty.  There is no ambiguity – either the money was spent or collected (or it wasn’t).

That is why to get to cash flow, we have to essentially back out all of the uncertain and speculative stuff to bring us back to JUST the amount that Penny and Ernest have run.

If Ernest has run further than Penny, the difference between them will be your positive cash flow.  If Penny has outrun Ernest, then you have negative cash flow, which means your bank balance has gone down during the period and you need to focus on unlocking more cash and getting it into your bank account to keep your business (or your personal finances afloat).

Financial Foreplay® Highlights:

1. Cash flow is a certainty – focusing on cash flow is far more powerful than spending time running endless forecasting scenarios that may or may not come to fruition
2. Money can move out of your business in two different ways – it either leaves your bank account completely or it can get trapped, which means that you can pinpoint, unlock it, and put it in your bank account
3. Cash flow is actually very simple – it’s just the amount that your bank account has gone up or down by in a period of time
4. If you can visualize every transaction as fuelling the forward movement of either Penny or Ernest (or them standing still), you can easily start to visualize where your cash flow position is at and what you need to do in order to ensure that Ernest always runs faster and further than Penny.