The number that replaces your bank balance is the cash-bills ratio, and the name describes it fully: your holdings set against your debts. It has two sides, and most self-employed people get both of them wrong in the same direction. They count more money and more debt than they really have.
Two sides, counted at the same moment every week
The source defines the cash side as the money in the bank, taken from the previous week's bank statements, plus the cash in hand at a fixed day and hour of the current week.
Two requirements hide in that definition, and both are easy to miss. The first is that the figure comes from reconciled bank statements, and the banking app on your phone does not count. The second is that you count at a fixed moment: the same day and the same hour, every week.
Your bank balance on its own is a real number, and it tells you almost nothing. It takes no account of what you already owe, and it ignores money you have earned and not yet collected. The ratio puts what you owe next to what you hold. You can work it out yourself, and no accountant or software is needed.
The fixed moment is what turns a single figure into a comparison. Suppose a business coach checks her balance whenever she happens to think of it. Every look shows a different picture, and she has nothing to set any of them against.
Now suppose she picks a day and an hour for the count. After a month she has four numbers she can line up side by side, and together they already tell a story about the business.
Cash is only money you could spend today
Here the source adds a requirement that kills the most common trick in small business. The cash you count has to exist in reality, as money you are actually able to spend.
That means an overdraft facility stays out of the count. So does the money that is supposed to land on the tenth, and so does a post-dated cheque. Only what you could spend today goes in.
Suppose a photographer includes his overdraft limit in his cash. He tells himself he holds $40,000, and $25,000 of that is debt he has yet to incur.
Or take an installer who books cheques dated ninety days ahead as cash. Month after month for a quarter he believes he is making a profit, and the money is still not in his hands.
An overdraft facility is permission to owe, and the money in it is not yours.
On the debt side, count what falls due now
On the other side sit your liabilities, and here the source separates two things in a way that is worth real money. You count the debts of the business, the overdrafts, and the current payments due on a mortgage, on purchases in instalments and on loans. The full total of the mortgage or the loan stays out.
The source gives a simple reason. What the business is called on to pay is the current payment, so adding up every balance for all the years ahead makes no sense.
This is where many self-employed people get stuck. They see a large loan and feel unable to pay what they owe, while the payment that actually leaves them each month is a fraction of a good week.
Suppose a pilates studio owner is repaying a $180,000 loan over seven years. Her monthly payment is $2,600, and for two years she turned down new equipment because she felt she carried an enormous debt.
Then take a garage owner who started counting only the monthly payment. He found that his business had been profitable for two years without his ever knowing it.
A debt can run for a long time and still be small. What matters is how much leaves you this month.
The two-shilling example
The source closes the subject with an example from a Dickens novel, and with a sentence that is easy to remember: “solvency depends on how you handle things, not on how much you have”.
Micawber, a character in David Copperfield, explains it in shillings. A man with twenty-one shillings who spends a pound is happy. A man with nineteen shillings who spends the same pound is miserable. And a pound is twenty shillings.
The gap is two shillings. The same spending, the same man, and two completely different realities. The difference lies in the ratio between what comes in and what goes out, and the size of the sums does not change it.
Suppose a physiotherapy clinic owner takes in $22,000 a month and spends $20,000. Hers is a working business. An IT consultant earns $45,000 and spends $47,000. She has no business, even though she feels she is doing better than the clinic owner.
The booklet gives this chapter two short exercises, and both are calculations. In the practice section at the end you will also find one called the two numbers, and another called the weekly ritual.
Whether you have money is answered on both sides of one number: what you could spend today, against what you must pay this month. Your bank balance gives you only part of the first side.
The booklet is general knowledge, not financial advice for your business.