– A Detective Story
I started working with a 200+ acre multi-generational farm a few years ago. After reviewing their income statement they asked me why they were making a “profit” but didn’t have any money in their bank account—it didn’t make sense to them. So we started a systematic approach to figuring out what was going on.
Detective Work – looking for trends and issues in the income statement.
We exported the income statement, by quarter, for the last 2 years into excel.
- We looked at Cost of Goods Sold as a percentage of sales, where there quarters that were particularly high low—could we explain the variability?
- We reviewed general expenses to determine if there were any abnormally high or low expenses. By reviewing multiple quarters next to each other we could see trends in many areas, but nothing that told us there was something out of the ordinary.
We did determine that there was little consistency in the manner in which expenses were recorded, and how sales and costs related to each other, but it clearly showed they had a 12-month profit of nearly $150,000 – but where was the cash?
Sleuthing To Solve the Mystery – looking for trends and issues in the balance sheet.
Again, we exported the balance sheet, by quarter, into excel for the last 2 years.
We reviewed inventory, accounts receivable, assets (equipment), accounts payable, and debts (liabilities) and here is what we found:
- Inventory wasn’t changing at all.
- Account Receivable was up.
- Assets were up by nearly $400,000 from just 12 months earlier.
- Accounts Payable was up a lot, too.
- Debts were about the same.
The balance sheet here was not being used as a tool to understand the overall health of the business, or to see trends over time. Many business owners tend to focus on the profit and loss statement because that gives us the real-time information we need, right? Well, after reviewing the balance sheet in detail, here is what our detective work uncovered:
- They were building Inventory through monthly slaughter and harvest, but they didn’t record the changes in inventory levels each month.
- Accounts Receivables were not being proactively managed. That means that cash wasn’t coming in on time, nor was it being chased.
- Assets were up. The bookkeeper was capitalizing any “project-related” expense over $500. Why? So the profits looked better, but it was still cash going out of the business, lots of cash. But, according to the owners, these projects were critical and had to be done.
- Accounts payable was up too, because they couldn’t pay bills fast enough, because lots of projects were being done tying up cash.
- Debt – Finally, and maybe most important—there was no increase in debt.
Okay, so now what?
This is where a balance sheet can be a tool to affect real-time change in your cash flow and day-to-day operations, and here’s what we did to improve cash flow by almost $70,000 in one month:
- Inventory – We took an inventory and ran a sale on product that we were overstocked on – remember to keep your cash in the bank account, not storage. We gained nearly $30,000 in cash here.
- Accounts Receivable – We called anyone with invoices over 30 days—just a simple reminder gave us $10,000 more.
- Assets – We stopped doing projects; or at least projects that could be done in the future—cash savings equaled about $30,000 per month.
- Accounts Payable – We called our vendors, were straightforward and honest with them and suggested a payment plan that could bring down our payables—systematically.
- Debt – Not increasing debt is a double edged sword…the good news is we didn’t get more bank debt to payoff, the bad news is it sucked all the cash from our profits out the door and we had to rely upon our vendors for cash support.
Moving Forward We now watch for trends in the balance sheet and match cash outlays for longer-term projects with inflows, either from profits and/or equity or debt funding. Here are the concrete operational changes that resulted from our collective detective work:
- Inventory is done every month—we plan for sales and/or cash from other sources when we have too much inventory.
- We call our late accounts every 2 weeks.
- We justify our projects based on 1) return on investment and 2) the ability to fund them.
We proactively work with our vendors, we don’t dodge their calls and we explain how we’re going to get them paid. - We look for funding for projects when appropriate. We have explored traditional bank loans, investors, direct public offering (DPO), customer pre-pays and many more creative funding strategies, but we know when we need cash in excess of our cash flow from our business that we have to find the funding BEFORE we do the project, regardless of the return. We have completely re-organized the Income Statement and Balance Sheet. We have aligned our sales with our costs, so we know how each and every enterprise in the farm is doing. We conduct monthly inventories and we communicate with our vendors, banks and investors every month. We’re growing at nearly 20% each year and are doing so profitably.