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Master your financials with these 3 numbers

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In celebration, I’m going to introduce a concept today and expand on it each of the next 3 weeks leading up to the cohort. I’d love to hear what you think of this style and if you think I should incorporate these types of series more often.

When I talk to business owners and leaders, I hear over and over again how complicated Accounting and Financial Statements are.

As someone who has done this work my whole career, I actually agree. Accounting is way too complicated.

The reality is, most people only want the answer to a few things:

1. Am I making money?

2. Do I have enough cash?

3. Is my business growing?

When I came to this conclusion, I realized something: you only need to know 3 things to know how your business is doing:

1. Profit

2. Cash flow

3. Enterprise Value

In this edition, I’m going to give an overview of each and in the subsequent 3 issues I’ll break down one of the 3 elements.

Profit

I’d bet most businesses only look at their Income Statement. The Income Statement is pretty simple. Revenue comes in and expenses go out. What remains is profit.

This is the financial gain (or loss) from the transactions during that period of time. There is something called the matching principle which applies when looking at Accrual Financials that makes this true, but that’s outside the scope of this post (maybe next week).

When you generate profit, you show that the business is healthy. If you get granular, with every item/service sold, you make more money. We’re staying simple here, so we’ll ignore fringe cases here.

But, because we’re assuming Accrual Financials, profit doesn’t necessarily mean cash in the bank.

This is where profit alone falls short.

Cash Flow

Cash flow is exactly what it sounds like. During a period, you have to understand what cash goes in and comes out of the business.

This is reflected best in the Statement of Cash Flows. But, who can actually read that thing?

Cash flow is what actually “feeds” a business. When you have cash coming in at a greater clip than it’s going out, you can:

• reinvest

• fund growth

• pay out dividends

Many think this is profit, but it’s not at all the same. So, how do we measure cash flow?

I’ll dig in deeper on this in 2 weeks, but a few ways:

1. Tracking your cash balance

2. Operating Cash Flow

3. Free Cash Flow

Enterprise Value

Enterprise value is a term used in the markets, but that formula is not what we’re talking about here.

Ultimately, business comes down to this. Is your business creating value, thus making you more money?

Enterprise value can be created from profits and cash flow, but it can also be created through asset and liability distribution.

This means we need to look at the Balance Sheet.

There are a number of ways to measure this:

• Return on Assets

• Return on Equity

• Company Valuation

• Return on Invested Capital

• Return on Capital Employed

And many many more.

As we go through these next few weeks, I’ll be breaking these down more granularly and hoping to clarify these concepts.

Ideally, you’d take one measure from each of these buckets and have all the key metrics you need to understand your company's health.

Thank you for reading--see you again next week.