You just can't stay stuck there. That's the key. You can't stay stuck, and I could tell you businesses that have struggled once before, that were like on the brink of bankruptcy, have turned around when they start paying attention to the right things. 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, cheers and enjoy. If you're running a business, do you ever feel like you have a ton of cash coming in, a lot of money going out, and you're stuck in the middle wondering where the heck is it all going? If so, you're not alone. I've been in that exact position before and I could tell you a lot of other business owners struggle with this concept of cashflow before, and I could tell you a lot of other business owners struggle with this concept of cashflow. So today we're going to talk about cashflow, how to forecast it, how to manage it and how to get more of it. But here's the deal. Let me just say this If you struggle with cashflow, it's not your fault. Even if you have a business degree and you studied accounting and finance. It's still not your fault. Even if you have an accounting team or you work with a CPA or a bookkeeper, if you don't understand cashflow, it's still not your fault, and here's the reason why Number one schools do a terrible job teaching about cashflow. I know this because I have my undergraduate in accounting and finance. I have my CPA. I did my master's in accountancy. I did my MBA with an emphasis in finance and strategy. I know I'm a slow learner or I like books or something I don't know what it is, but despite all this, I could tell you that I can count on my hand the number of times I've come across somebody in my life who truly understands free cashflow and most CPAs. I'm a CPA, but I can tell you most CPAs they focus on profit or taxes and they don't really pay attention to free cashflow. So today we're going to jump into it and you're going to leave this episode feeling so much more confident because we're going to break everything down and I'm going to make it really simple.

All right, so let's just talk about the high level definition of free cashflow. Ultimately, it's the amount of cash that's left over in your business After you pay all the expenses. You account for working capital and capital expenditures I'm going to talk about that here more in a minute and it's the amount of cash that's left over to do three things to pay down debt, to return to equity providers or to reinvest in your business. Now, the breakdown doesn't have to be that complicated, but I'm going to walk you through it so you understand how to derive it from your financial statements. If we begin with the income statement and you start with the top line, you have revenue that represents all the income that the business generates from selling its products and services. Then, if you subtract out cost of revenue, you arrive at gross profit. Now, what's in cost of revenue? You may have direct labor, material costs, subcontractors or any other direct or indirect costs associated with fulfilling your product or service to your customers. All right. So revenue minus cost of revenue, we arrive at gross profit. But we're not done yet, because we also have to account for operating expenses. Operating expenses have three main categories sales and marketing, general, and administrative and research and development. Combine those three together, you get operating expense, also known as OPEX for short, if you want to sound cool. And if you take gross profit minus OPEX, you arrive at EBITDA.

Ebitda is just a nerdy way of saying profit. It stands for earnings before interest taxes, depreciation and amortization. And I'll tell you here why we exclude interest taxes, depreciation and amortization, because that's what EBITDA is it's profit, excluding those things. Number one you ignore interest because we don't want to account for the capital structure of a business. So one business may have a lot of debt, whereas another business may have a lot of equity. So when we want to compare profit, apples to apples from one company to the next, ebitda is a great way to do it because it excludes interest, right. The same thing is true with taxes. There are a lot of nuances when it comes to taxes with businesses. Some may have tax credits or lost carry forwards, et cetera. So we're just going to exclude taxes so we could look at businesses on an apples to apples basis, all right for now, and then with depreciation and amortization.

The reason why we excluded at the EBITDA level is because we can compare companies without regards to how they invest in property, plant and equipment and the methods they use to depreciate or amortize that property, plant and equipment. All right, so we end up with EBITDA, and this is where most companies stop and in fact this is where a lot of forecasts stop. They stop at EBITDA, this profit line right, or some variation of EBITDA, and business owners are like, okay, we're good, we know what our EBITDA is and therefore we can run the business effectively. Wrong, because at EBITDA we still have to keep going. Ultimately, we subtract out depreciation and amortization for tax purposes. Then that leaves us with EBIT, e-b-i-t.

We took out the DA in EBITDA. Right, because for depreciation and amortization, although they're a non-cash item, they are tax deductible and we have to get down to our net operating profit after tax. So we have to subtract it from EBITDA. Then we're left with EBIT. Like I said, we account for taxes and then we're left with net operating profit after tax.

Nopat, we're not done yet, though. We add back depreciation and amortization because, like I said, they're non-cash items and we're trying to get to cashflow, so we add them back to notepad. Then we account for changes in working capital and essentially, changes in working capital is the difference between your current assets and your current liabilities from one period to the next. And this is where a lot of companies get tripped up, especially in their forecast, because it's really hard to forecast current assets and current liabilities. More on that here in just a minute. But also we have to account for capital expenditures, capex. So you take NOPAT, add back depreciation and amortization, account for changes in working capital, subtract out capital expenditures in other words, investments and property plan equipment and bingo, we just arrived at free cashflow. So I know I went through that pretty fast.

If you want to learn more about this, by the way, I have a free program at boosting your financial IQ byfiqcom. In fact, you could take it. It's called the financial pro. It's totally free, it's over a hundred video lessons and there are no gimmicks. You just go there, you sign up, you can learn from an app, you can learn from your computer, you can learn from anywhere in the world, and it's all free, zero dollars. Okay. So check that out if you want to learn more about this breakdown and you want to see it visually. But nonetheless, I just walked you through free cashflow.

Let's talk about forecasting. Okay, because forecasting is really important, because it'll help you to understand where things are going into the future. Right now, I'm looking at an actual forecast that we built for one of our clients, and it's really cool because we don't just stop at the income statement. This is where a lot of forecasts stop for companies. They just build an income statement forecast. They have revenue, they have their expenses, then they have profit and they're like cool, we're good. Well, we don't stop there, because then we account for changes in working capital and CapEx. Those are items that you can calculate based on the balance sheet, if you build out a balance sheet forecast as well. Like I said, most companies don't do this. They just have an income statement forecast and I like to combine a balance sheet forecast as well so you can get down to free cash flow, because that's what it comes down to. All right Now, in an ideal world, it'd be great if companies also include a forecast for the statement of cash flows, but oftentimes that's just too challenging. Most companies don't even generate a statement of cash flows because it's so nuanced, which is fine. But if you have a forecasted income statement and a balance sheet, then you can get the free cashflow and that's what's most important. All right.

So when it comes to forecasting, and especially forecasting working capital, there are really three main accounts you have to pay attention to accounts receivable the amount of money customers owe you, right. So if you're extending credit to your customers in other words, you go out there and perform work and then you say, hey, pay me in 30 days. That balance that accumulates from your customers is called accounts receivable AR, and that sits on the balance sheet under current assets. The next account is inventory. So if you're buying inventory, stockpiling inventory and you're accounting for inventory, that's going to show up under current assets as well and then under current liabilities. The biggest account is accounts payable. This is the amount of money you owe your vendors if they extend you credit. So if you go buy supplies and put it on account and you pay them in 30, 60 days or whatever it is, then you're going to be racking up accounts payable. So when you're forecasting out working capital, there's some other accounts that are combined in current assets and current liabilities. But your three main accounts to forecast and to get right, like I said, are accounts receivable, inventory and accounts payable.

The reason why cashflow is so hard to forecast is because of these three accounts. Because guess what, as a business, what accounts do you actually control? You don't really control revenue. That's up to your customers. You can control cost that's up to your customers. You can control cost that's up to you. You get to control the cost for your business.

But then, when it comes to accounts receivable, sure you can set terms on when customers pay you, but customers ultimately have the final say of when they're going to cut you a check. So trying to forecast that behavior can be really difficult. You may have 30 day terms and a customer turns around a payment in 10 days. Or you have 30 day terms and a customer pays you in 45 days, and they're naughty right, they're rebellious, they don't follow your accounts receivable policy. With inventory you can plan for that a little bit easier to forecast, but still it could be challenging. And then accounts payable you can plan that because you could choose when to release payments to your vendors. But accounts receivable, that's really the challenge of forecasting for cashflow.

But I'll tell you this when you build a balance sheet forecast, I would do accounts receivable and forecast it in days of revenue. I would forecast inventory days of cost of goods sold, because inventory is more related to cost of goods sold rather than revenue. In accounts payable, I would also forecast that as days to cost of goods sold rather than revenue and accounts payable I would also forecast that as days of cost of goods sold. All right, so those are the three main components of working capital and then capital expenditures. You can plan for those. If you're going to go buy a truck or a tractor or invest in a building, whatever it is, your property, plant, equipment you could build a schedule for that. Not as difficult to forecast, for it's just your working capital that's going to be the biggest culprit, assuming that you do a good job up above in revenue and your costs, et cetera.

But looking at this forecast right here for this client, I always tell them look, if I show you having $120,000 in positive cashflow, we may be off by, you know, 20 or $30,000 because of those swings that I was just talking about. But looking forward, it's not about precision on a month-to-month basis. Now, of course we wanna be accurate, but you're not gonna know five months out whether you're gonna have $120,000 in positive cashflow or whether it's gonna be 119 or 118. It's impossible to forecast with that type of precision. However, if I can build out, at least I know in five months that we'll roughly have $100,000 in positive cash flow, versus having no visibility whatsoever in what the future holds. So close enough is good enough when it comes to cash flow forecasting, but at least have visibility into what the numbers may look like, because I could tell you, if you look out into the future and you have negative cash flow of $300,000, you got a major problem. Even if it's not $300,000 exactly, maybe it's 250, that's still a problem. So understanding cashflow and forecasting for it can be very valuable in building it out month by month and making it rolling is really, really important.

Now, when it comes to managing cashflow, there are levers you could pull. Number one you could do more volume. Number two you could do more volume. Number two you can influence your price. Number three you can reduce your cost of goods sold. Number four you can manage your overhead, your op-ex. We talked about working capital and capital expenditures. You can manage your risk, and then you could also put in place a strategy to drive all of this All right.

So, when it comes to managing your cashflow, those are the seven levers that we help companies to understand and to pull on a regular basis to improve the performance of their business. So how do you get more of it If you want more cashflow? That's where it comes down to strategy. So I talk about strategy all the time how businesses can have a really good strategy to drive higher cash flows. Now, strategy isn't all about generating more profit or more cash flow. Instead, high profit and high cash flow is the result of a good strategy. So when you have a strategy, you have to determine where you're going to compete, how you're going to compete and, ultimately, how you're going to win. And when you can determine all this and you have a solid strategy that you implement with your company and you review it on a regular basis, that's where the magic happens. So that's what I wanted to talk about today is cashflow.

And, like I said at the beginning, if you struggle with cashflow, you're not alone. It's not your fault. A ton of people struggle with cashflow. You just can't stay stuck there. That's the key. You can't stay stuck because there are tools, there are resources to help you out, and I could tell you businesses that have struggled once before, that were like on the brink of bankruptcy, have turned around when they start paying attention to the right things. All right, that's what I'll leave you with today. If you want to talk more about this, you could always reach out at Coltivar. com. I'd love to talk to you more about your strategy and about improving cashflow.

I also just released a book. It should be out on all the platforms on Amazon, audible, et cetera. If you want to check that out, it's called cashflow, and I go into more details on all this stuff right now, as of the date of this recording, this may change in the future, so if this changes, don't get mad at me. But right now you can get cashflow for free by going to Coltivar. com. All you have to do is pay for the shipping and handling. If you live in the continental US, I'll cover everything else the cost of the book, the printing, et cetera and that's my gift to you. If you want to check that out. Like I said, in the future, if this offer goes away, don't get mad at me. You have to act now. All right, have a great week and until next episode, take care of yourself. Cheers.