Accounting: Your Spread
Have you ever gone driving with your eyes closed?
Being so busy growing the company and not watching the numbers at all is like stepping on the gas and closing your eyes. You’re going somewhere but it might not end so well. Let’s extend out our illustration, assuming that you at least look at your financial statements: if you’re looking at your numbers only when you look at your financial statements, it’s like relying solely on the rearview mirror of the car – you find out what’s happened after the fact. Financial statements are like history books and we need to understand our history so that we can chart a better course today and into tomorrow.
But the rearview mirror isn't enough by itself. We need to go about growing our business with our eyes open and looking out the windshield. How? Well, lets talk about a bathtub.
What can a bathtub teach us about our financials?
Plenty actually. Let’s say the faucet is receivables (money customers owe you for work completed), the drain hole in the bottom of the tub is payables (bills that you’ve received but not paid yet), and the water in the tub is cash:
You’ll notice that in our illustration, the level of the water is labeled ‘Spread’. To calculate your Spread take
Cash + Receivables - Payables.
If the Spread gets high enough, you can take some money out of your company in the form of a “distribution to shareholder” – that’s the overflow drain. If the tub goes dry – meaning all the cash drains out – you’re out of business.
What’s the advantage of measuring your Spread and when should you do it? The first time you measure your Spread it won’t mean anything to you. Is what you see good or bad? Not easy to say, because it’s one data point. The power comes when you look at the Spread over time and start seeing patterns of change:
(5+ years of ABC Co’s Spread numbers)
The Spread is something you should measure at least once a month, and even twice a month in periods of change or crisis. It’s very easy to measure and understand. What’s the value? If you can see how your financial picture is going before it happens, then you can act and make adjustments before you get in financial trouble.
Ask your accountant to place the numbers in a line chart form, this way it is very easy to see the history and trend of each number. Try out using Your Spread to help you get better grasp on your finances.
Your Spread is an exercise in Contractor Nation’s School of Entrepreneurship program, the core knowledge of Contractor Nation. If you’re interested in learning more about this exercise or the program itself, please let us know.
See you soon.