Profit vs. Positive Cash Flow

In every McKinsey engagement, there’s a moment when the senior client says to us, “Hmm... that’s interesting.”

That is the moment when the client thinks to him or herself, “Okay, maybe the $1 million consulting fee was worth it.”

You might be wondering what the McKinsey team says to the client that prompts that reaction.

It was an...

Insight

An insight occurs when the client’s perspective and understanding of the business shifts.

Amongst all insights, the “counter-intuitive insight” is by far the most impactful.

When a client comes across a counter-intuitive insight, it’s a significant moment because it means there’s a major deviation in the client’s mental model of the business and his/her new understanding of it.

In other words, the client wasn’t just wrong about some facet of the market, competition, or company. The client was 180 degrees wrong.

“Hmm... that’s interesting.”

The single most significant source of counter-intuitive insights comes from doing “the math.”

I’ll give you a simple example that applies to startup founders.

Most founding CEOs seek growth and fear bankruptcy. They’re obsessively concerned that their sales growth will be too low to generate enough cash to pay the bills.

So in their minds:

Slow Revenue Growth = Bad

Fast Revenue Growth = Good

However, if you truly understand accounting and the relationship between the cash flow statement versus the profit and loss statement, it is totally possible to go bankrupt by growing too fast.

So yes,

Slow Revenue Growth = Bad

Fast Revenue Growth = Good

Extremely Fast Revenue Growth = Bad

“Hmm... that’s interesting."

If what I just said is counter-intuitive to you, then you just experienced an insight. (And it also means your understanding of finance is insufficient to be a CEO or General Manager of a company or division of a larger company.)

The key is the timing of when revenue is collected.

When a contract is signed, that’s revenue.

When revenue is collected, that’s called positive cash flow.

Let's say you land a Fortune 500 client. They sign a contract to pay you $100 million. You have to staff up to handle the business, so your expenses will be $50 million.

That’s a “profitable” deal.

However, if you have to pay the $50 million in expenses today, but you get paid by the Fortune 500 account at the completion of the project, that’s called bankruptcy (or a majorly negative cash flow deal... at least initially).

Understanding the math gives you insights.

Sure, math has its limits. But ignoring the math completely or not comprehending what it means invites disaster.

By the way, for a practical crash course in financial concepts and how to ask questions that stump CFOs, see my Financial & Data Analysis Toolkit.

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