You have to pay for a lot of things out of pocket first before you get paid back from your customers. But guess what? All that inventory that's sitting in the back room or up on the shelves, that's cash. That's cash trapped in inventory. This is Boosting your Financial IQ, where I help business professionals with financial responsibility to elevate their careers and run profitable companies. My hope is that you'll apply these lessons to achieve your greatest ambitions. My hope is that you'll apply these lessons to achieve your greatest ambitions. Cheers and enjoy Check this out. You have profits, but you have no cash. I'm going to explain to you how this happens and what you could do in your business immediately to turn things around.

Now, this is a common theme that I hear from people, especially those who are running businesses. They're like Steve my business is profitable, but I have a serious cashflow problem. In fact, that's probably one of the main reasons why people start working with me and my team at Cultivar is that they run into cashflow issues and they're like Steve okay, we need a better forecast, because the one that we're using right now from our account day or our CPA sure, it gets us down to profit, but we're having cashflow issues, so it's not super helpful. And that's where I come in. 70% of businesses that go bankrupt are profitable when they close their doors, and the reason why is because they don't have cashflow. So that's what I want to point out today in this episode is that your business may be profitable, it may be wildly profitable. You may have 10, 20, 30% profit margins net profit margins but then when you look at your bank account, you're like I have no cash, like it's showing one number on my profit and loss statement, steve but when I look at the bank account, we don't have cash. And you may be drawing on your line of credit, you may be avoiding your vendors, you may be doing a bunch of weird things, like swiping your credit card just to cover the bills, and you're like what's going on? I thought we're making money but we have no cash, and this is a big, big problem with businesses and if you don't fix it, you will go bankrupt. All right, sorry, that's a little abrupt, but that's just the cold, hard truth. The other thing is is that your business may be profitable and you may have cash in the bank, and you're about to double down on your paid ads or on the number of leads you're bringing into the business. In other words, you're about to pour gasoline on your growth engine. If you do this without understanding these two things that I'm going to share with you, you can grow yourself out of business.

I see it happen all the time. Just last week, I was working with one of my clients and they have a working capital issue because they have so much of their money tied up in accounts receivable and something happened in their system. They had some transitioning with their FinOps team and guess what? Accounts receivable went to the wayside. And I see this all the time. Their credit policy is non-existent. There's no follow-up process when their invoices go past due. They're not offering discounts to clients, they're not offering the option to pay early or to pay in advance to get a discount, and therefore their accounts receivable has run amok. And guess what? They have so much of their cash tied up in accounts receivable that it's constraining the business, and this is the number one constraint they're facing when it comes to their growth. And guess what? Their working capital is also 23% of the revenue, which is crazy high. So check this out.

I was talking to the CEO. I said look, if you grow your business by $1 million in revenue and your working capital ratio is 23%, guess what? You're going to need $230,000 in working capital in order to support that revenue. Now, if you're like, what the heck are you talking about? Steve, let me explain.

In business, working capital comes down to this you have to pay for a lot of things out of pocket first, before you get paid back from your customers. So you go out there and say you have a bunch of inventory in your business. You have to, like, shell cash out of your pocket to build up inventory to sell to your customers. But guess what? All that inventory that's sitting in the back room or up on the shelves, that's cash. That's cash trapped in inventory. And or up on the shelves, that's cash. That's cash trapped in inventory. And you're not going to collect that cash back until you sell the inventory. The same thing is true with accounts receivable. Accounts receivable is you go out there and do work and a customer is like yeah, yeah, yeah, I'll pay you, but give me 30 days. Well, it's not like you go to your employees and say yeah, yeah, yeah, I'll pay you, but in 30 days. No, you have to make payroll. So you're paying your employees in advance and maybe you can buy materials and supplies on account, but if you're not, then you're paying for those in advance too, and so you have all these things that you have to front capital for, and that's called your working capital.

In other words, a basic definition of working capital is current assets minus current liabilities. Now what are the main accounts in current assets, you may wonder. Well, you have cash and cash equivalents, you have accounts receivable, you have inventory, you have prepaids, and then you have some other current assets. Current just means within 12 months, so it's money you're supposed to collect on in the next 12 months, right? That's everything in current. And then you have current liabilities. So current liabilities is primarily comprised of accounts payable. You may have some accrued expenses, you may have payroll liabilities. So, in other words, you make payroll, but you withhold payroll taxes from your employee's check and you have to match certain taxes. Well, guess what? You have to submit those so that cash is sitting in your business. It's just a liability right now, but eventually you have to submit it, right, so you have to account for that. And same thing with, like, gift cards or other things that are due and payable in your business are going to sit in current liabilities. So if you take current assets minus current liabilities, that makes up working capital.

But if you want to get even more granular, I like to look at operating working capital. So I'll take current assets minus excess cash, less current liabilities minus interest bearing debt. So if you have a revolving credit card that you're paying interest on, or a line of credit or short term debt, the current portion of short term debt is sitting in current liabilities. You're going to want to exclude that from the calculation. So that's working capital, right? That's the biggest killer of businesses, right? And if you don't understand what this is, in your company, like I said, you're going to grow your business but, like, the working capital demands are going to be so high. And if you can't get a line of credit or if you don't have equity in the business to cover these working capital needs, guess what? You got a business. And I've seen this over and over again, especially with companies that have a lot of inventory. So let's just say, you double your business, you have a million dollars in inventory. Well, you're going to have to invest in another million dollars as you double your business. Theoretically, right. So you have to be very, very careful of this.

The next thing is CapEx, which stands for capital expenditures. This represents your property, plant and equipment. You can find this number on your statement of cash flows under investing activities. But guess what? Capex just like working capital doesn't show up on your income statement. It's not in your profit number, it's outside of your profit number. So you can have profit in your business, on your books, but you're not looking at working capital and you're not looking at CapEx.

That's why I love free cash flow, because free cash flow takes cash from operating activities on the statement of cash flows, which already accounts for profit and working capital. Changes in working capital, which already accounts for profit and working capital, changes in working capital, and you subtract out capital expenditures from investing activities on the same amount of cash flows and you arrive at free cash flow. This is the amount of cash that's available to pay back equity providers, to pay down debt or to reinvest in your business. It's not profit. When you look at profit, profit does not equate to the end-all be-all. That's not cash flow, it's not the.

So that's the biggest thing that I wanted to point out in today's episode, because it's where people get stuck the most in business. When I'm talking about profit. They're like, yeah, we have profit, we're great. And I'm like, yeah, but you're like a few weeks away from being illiquid and running out of cash. And I have to explain that to them the whole idea of working capital and CapEx and they get it. They're smart people, but it's just something that if you could understand from the get-go, you're going to be so much more successful at managing the cash flow in your business and making strategic decisions to ensure you minimize the amount of capital that's required in your company.

In my financial pro program I talk about return on invested capital as a huge metric in businesses, because return on invested capital accounts for the invested capital and working capital and CapEx. I know I just said a lot. I'd probably hurt your head there, but my point is is that you know, most finance courses aren't talking about invested capital. They're talking about revenue and cost of goods sold and profit and it's like whippity, doodah, that's great. But who's talking about invested capital and cashflow and like strategy and combining these things together to drive greater value in your business? That's the stuff I talk about, because that's what makes all the difference in the world and the business.

So if you don't know what I'm referring to. This is where I'd encourage you to increase your financial literacy, because if you don't like, you can find yourself in a lot of trouble, even if your business is profitable. All right, that's all I have for you. If you want to learn more about the courses that I have related to financial literacy, you go to byfiqcom. You could actually get started for free or keep consuming this content and you'll get yourself there. I'm just glad that you tuned in and if you found value in it, it would mean the world to me for you to comment and share. All right, take care of yourself. Cheers.