Many years ago I was told the banker’s mantra and it’s always stuck with me as the explanation for why all businesses need effective financial control.
Turnover Is Vanity, Profit Is Sanity But Cash Is Reality
Read it in, learn it and take it to heart.
It contains one of the core secrets to long term business success.
Turnover Is Vanity
Perhaps you don’t use the word turnover so please, insert your word… sales revenue, fees receivable, gross income into the sentence “… is vanity.”
I don’t think it’s just men who believe that size really does matter and bigger is better.
When I talk to people about the business they want, I usually hear at the start “Sales of £500,000 or £1 million or £5 million per year and as they talk, they rarely mention annual profit and I’ve never yet heard anyone set a cash flow goal.
In my article:
>>> Contribution Margin Is Your Real Income – Don’t Be Fooled By Sales Revenue
I explain that sales revenue or turnover is not a reliable guide to business profitability.
Turnover can easily go up and profit go down.
In the article:
>>> How Break Even Analysis Can Guide Financial Decisions
I show you how simple financial analysis can help you avoid making mistakes.
In big businesses, the “turnover is vanity” problem is particularly acute. that’s because senior management pay is often based more on the size of the business than its profitability.
That’s not an issue with business owners who are managing their businesses on a day-to-day business.
However sales revenue and growth is perhaps the talk at the nineteenth hole at the golf club or in the country club lounge. Just as you wouldn’t normally boast about your salary if you were employed, business owners would probably see it as vulgar to tell people about profit.
Profit Is Sanity
What you’re really in business for is to make a profit.
Hopefully a nice, big, fat, juicy profit that increases year-on-year.
It’s essential to understand Break Even Point Analysis as so much of your thinking about profitability needs to be based on it.
If you plan to sell your business within the next five years, you need to give profit a particularly high focus.
Most businesses are sold on a multiple of profits.
Sometimes of the profit last year, sometimes the average profit for the last three years, sometimes the estimated profit for the first year of new ownership.
You will get paid many times.
If the price multiple is five times profit and the profit is £100,000, then the business is valued at £500,000.
If you make £20,000 more profit, the valuation of the business increases by £100,000.
(5 * £120,000 = £600,000)
The same logic applies if you’re planning to sell part rather than all the business. The better the profit, the more valuable the business.
No wonder profit is sanity.
Cash Is Reality
The calculation of profit is based on various assumptions and judgements.
There’s no point beating around the bush… the books can be cooked.
Auditors are paid to make sure that the accounts show a “true and fair view”.
Not correct because no one would agree but approximately right or at least not misleading.
But the cash in the bank is fact.
The cash flow – the movement between the opening and closing Cash and Bank values – is fact.
Cash is reality.
The emphasis on cash goes deeper than that.
In the end, cash is what really matters to businesses.
If you have cash, you have options.
If you don’t have cash, you have problems.
Businesses go bust because they run out of cash. They can’t pay their employees or suppliers.
The blunt truth is that…
No cash = no business.
>>> Why Cash And Cash Flow Are Important
Profit Does Not Equal Cash
In the most simple of businesses, there is virtually no difference between profit and cash.
But as businesses get more complicated, gaps open up between:
- The date of accounting transactions.
- When the cash related to those transactions move from customer to business or from business to employees, suppliers and other parties.
- The period or periods when the transaction is reflected in the Profit & Loss Account.
I will be writing about this in more detail.
>>> Profit versus Cash – How Timing Differences Cause Confusion
Why Is It Called The Banker’s Mantra?
The saying “turnover is vanity, profit is sanity and cash is reality” captures the problems that bankers see.
Too often they are asked to fund unprofitable growth backed by hockey-stick financial forecasts which show profit and cash flow going down before the “magic” happens and everything is hunky dory once gain.
Too often, business owners see borrowing money as the easy solution to a performance problem.
It’s the other way around.
Solving the business problem will solve the cash flow problem.
Since the Credit Crunch, it’s fashionable to criticise the bankers and they certainly deserve some of the criticism they get. They would have done well to remember their own mantra.
I also like this saying allegedly from Chinese philosopher Confucius:
You ask credit;
I not give;
You get mad.
I give credit,
You not pay;
I get mad.
Better you get mad!
Another reason why cash is reality.
Turnover Is Vanity, Profit Is Sanity But Cash Is Reality
Please remember the saying.
Focus on delighting customers but…
- Think Profit.
- Think Cash.
The Alternative Version – Cash Is King
I have seen a second version of this saying that has a slightly different ending.
Turnover is vanity, profit is sanity but cash is king.
I prefer my version, partly because of the alliterative endings of vanity, sanity and reality.
Partly because there is nothing more real than having or not having cash in the bank with the payroll due to be paid.
Partly because there is nothing more real than cash when you’ve got to pay the employees on Friday.
Who first said it?
I’ve seen it attributed to Alan Sugar and one of the Dragons Den entrepreneurs but it’s not them originally. I’ve known of the saying for nearly 30 years.
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