Business Physics: The Four Forces of Cash Flow - Getting Naked Chapter 4
Chapter 4: “Business Physics: The four forces of cash flow”
“Cash is the most powerful opportunity magnet ever created” - Greg Crabtree
Another word for Chapter 4 is discipline!
There has been many times in business that I have asked the question, where did my money go? Mr. Greg Crabtree opens chapter 4 by reminding us that money is depleted because we spent it, bought some assets and then sold them, or bought some assets and kept them. Accounting is a closed system. For every debt there is a credit.
Have you heard about the 4 forces of cash flow? They are as follows:
- Paying your taxes (Force 1)
- Repaying debt (Force 2)
- Reaching your capital budget / building working capital (Force 3)
- Taking profitable distributions (Force 4)
Yes! In this exact order, paying taxes is the number one priority for every business owner and taking profit distribution is the last. It is important to note that it is essential you pay yourself the market rate salary, provided that your business can afford it. Paying yourself a proper market rate will take the pressure off taking profit distributions prematurely.
An example of the 4 forces of cash flow is:
Let’s say the total available cash you have is $225,0000 ($125,000 is pretax profit).
Force 1: Pay your taxes of $50,000
Force 2: Pay your loan of $50,000
Force 3: Core capital of $100,000
Core capital target is usually referred to as working capital. Your core capital target is two months of operating expenses in cash and nothing drawn on a line of credit. In this example your company’s core capital target is $100,000 (two months of operating expenses).
Force 4: Leaving you with $25,000 for distributions
Chapter 4 contains a few important definitions and states that I would like to share with you:
- Distribution is a draw against equity of the business; the sloppiest way to handle distribution is to live off them.
- Your operating cash flow starts with your net income for the month. You then add back the difference in the changes in accounts receivable, accounts payable, and inventory (if applicable).
- Mr. Crabtree recommends case-based accounting because there is a much tighter correlation between the cash in your hands and paying taxes on that cash.
- For entrepreneurs, credit lines are the equivalent of crack cocaine. It’s that addictive. A true line of credit is one that goes to zero for at least thirty consecutive days in a twelve-month period.
- Do not confuse debt with capital. Capital is cash you leave in the business to fund your receivables and inventory for normal business conditions and debt is for financing for special occasions.
Chapter 4 key points:
- Discover where you cash goes
- Set aside your taxes in a separate account
- Calculate how much cash you need to get your line of credit to zero
- Borrow term debt only when you have a clear strategy about how you are going to generate the profits to repay the debt
- Understand that you should not take distributions while you are repaying the debt
- Once you get your business out of debt, do the same for yourself
- Build cash by retaining profits until you hit your core capital target
- Take distributions on a formal basis each quarter only after you have covered your taxes and hit your core capital target
REMEMBER; READING IS TO THE MIND, WHAT EXERCISE IS TO THE BODY! TAKE CARE, CONSTANCE
Download Crabtree Rowe & Bergers' PDF: How to Not Stress your Cash Cow!
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