I know a guy who ran his company this way – he’d ask his accountant “how much money is in the bank?”.
She’d tell him “$238,000”.
He’d say “OK I’ll take $150,000 today”.
No asking about payables or receivables or inventory. It’s caveman decision-making.
At my companies we measure what I call “The Spread”. You may call it a Quick Ratio.
It’s CASH + RECEIVABLES – PAYABLES. You could add the inventory number in there if that fluctuates significantly and is important. We measure it each month and keep a chart so we can compare it to last month, this time last year, and see the trend.
Obviously, the Spread had better be positive. We pick a target Spread number – for example, for a 5 million dollar a year company it may be $500,000 a year. For a 15 million dollar a year company, it may be $800,000. In some of my companies, it is far higher. You could have a formula of 60 days of G&A expenses including marketing.
No money comes out for distributions unless the Spread is over that. This way you have stored capital to survive if things turn down or don’t go the way you had planned. If you run out of cash, you are out of business.
This is not a substitute for reading and understanding your Income Statement (P&L) and your Balance Sheet.
Don’t be a caveman.
Good morning Larry. The spread is a great spot check for me. I learned from you about 2 yrs ago in one of your posts. I look at 5 metrics each Friday and share w my son Matthew who is transitioning into ownership. Spread, A/P, A/R, P+L Prev yr comp, P+L as % of Sales. If all 5 hit my target comfort. I enjoy my weekend and the “ Sunday Night Terrors” have gone away. Thank you for your daily notes! Ken
This is a great lesson in accounting.
Also, Lisa is a Rock Star!
Good morning from Canada!
Happy Independence Day!! (yesterday)
Would I include the 60 days of G&A expenses with the accounts payable? I know what my fixed costs are per month, so I’m wondering, how far out should I include upcoming overhead in my “accounts payable” part of the equation to account for future obligations? Or should I just measure it month-to-month for comparison?