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Managing Cash Flow in your Business

April 22, 2010 by Frank Goley, Business Consultant

The Cash Flow Statement is derived from the Cash Flow Budget, which is a forecast of cash receipts and payments.  The Cash Flow Budget shows if enough cash is available for expenses, equipment and goods purchases.  Cash Flow also indicates whether external sources of cash are necessary.  While many business owners think profits are the most important financial component of a company, the lack of cash is often the biggest reason for business failure.  In fact, a business may be profitable; yet, it doesn’t have the cash to pay its expenses.  Therefore, effective Cash Flow Forecasting, Planning and Management are essential to a Company’s success.

Cash Flow Planning is short-term (daily/weekly), as well as, long-term (monthly/quarterly/yearly) so a business has the optimum amount of cash on hand when required.  The Cash Flow Budget controls the flow of cash into your business to make necessary payments, while not maintaining an excessively high Cash Balance.  It is a function of Management because the efficiency, speed and effectiveness of moving cash through a business enables the business owner to turn it over into sales and income more quickly, resulting in greater profitability and minimized interest payments.

The Cash Flow Statement can be a complicated Financial to develop and manage.  Therefore, the Cash Flow Budget is a great place to start and is a very effective tool to manage your business cash flow.  The Cash Flow Budget has three principal sections to manage:

1)     Cash to be received

2)     Expected Cash Payments

3)     When payments are to be made

The monthly Cash Flow Budget is the primary Cash Flow format.  We recommend working on three months at a time and build out the Budget for 12-18 months projected in advance.  Each month should have a Budget Goal and Actual Column, and the Budget should be on a rolling basis (as you complete a quarter, budget another three months).

The first bottom-line for the Cash Flow Budget is the End of the Month Cash Balance, which is computed as follows: 

Beginning Month Cash Balance + Total Cash Receipts – Total Cash Payments. 

Simply put, a negative cash balance will require an increase in cash receipts, a decrease in payments, or accessing a short-term loan.  The second bottom-line is the End of Month Available Cash, which is calculated by subtracting the Monthly Contingency Cash Desired and Short-term Loans required. 

The third bottom-line is the Cash Required for Capital Investments, which is calculated by taking the End of Month Available Cash and factoring in Desired Capital Cash and Long-Term Loans Required. 

By effectively Planning your Cash Flow Forecast and Managing the various key elements of the Cash Flow Budget, a business owner can determine the right amount of cash available, when needed.  Please refer to the end of this blog post for a Cash Flow Budget Worksheet to assist you in Forecasting, Planning and Managing your Company’s Cash Flow. 

Resource:  Please refer to the ABC Business Plan Guide and Workbook for information on developing the Cash Flow Statement and Company Budgets, along with detailed financial analysis and formulas. 

Having constructed your Cash Flow Budget, you can now effectively manage your Cash Flow needs.  By using some numbers from your Income Statement and Balance Sheet, you can analyze your present cash situation and apply that to future Cash Flow analysis.  It is important to understand the relationships between your Financial Statements in order to effectively Manage, Plan and Forecast Cash Flows. 

A couple key formulas will help you predict and manage sales related Cash Flow issues¹:

1)     The Average number of days to collect money from customers or the Days Sales Outstanding (DSO):

(Accounts Receivable divided by Annual Sales) x 365

2)     The Average number of days to pay your bills or Days Payables Outstanding (DPO):

(Accounts Payable divided by Annual Sales) x 365

So how can the DSO and DPO be applied to your business situation?

1)     If your DPO is greater than your DSO, you can carry or float your bills longer than your customers do and cash will accumulate.

2)     If DSO is greater than DPO and your customers are slower in paying their bills, then cash is departing the business.

3)     When DPO is greater than DSO, the bigger the difference, the more cash is flowing into the business and vice versa.

4)     The difference between DPO and DSO, termed the Float, is the number of sales days in cash that is flowing in or out of the business each year.  The equation is:  (Sales divided by 365) x Float

a)     As an example: A $1.5M  Sales Revenue business with only eight days of negative float will see $33,000 in cash flow go out the door.  This problem can be compounded if the drop happens during one payment cycle.

So how can you fix negative cash flow? 

Well, it is really pretty simple.  A couple options:

1)     Collect receivables more quickly from customers.

2)     Obtain better payment terms from suppliers.

Combining options one and two will exponentially increase your cash flows, putting much less strain on your business operations and allowing you to manage more effectively for Profits. 

Resource:  For more information on Profit Fundamentals, Analysis, Planning and Application, please see our article on Maximizing Profits in your Business

Conclusion

In order to effectively manage Cash Flow in your business, you must understand the relationship between your Cash Flow Statement, Income Statement and Balance Sheet, and what these financials are telling you.  The Cash Flow Budget is the first step in developing your Cash Flow Statement, utilizing the numbers generated through your Profit Analysis and Income Statement and your Balance Sheet. The Cash Flow Budget is a great tool to manage and plan your levels of Cash Flow (please see an example Cash Flow Budget Worksheet below). 

Footnote 1: Entrepreneur Magazine, January 2009, “Keeping Tabs on Cash Flow” by David Worrell. 

Monthly Cash Flow Budget Worksheet Example

 

[ Monthly Basis; Budgeted and Actual Columns ]

Expected Cash Receipts:

1.     Cash Sales

2.     Accounts Receivable Collections

3.     Other Income

4.     Total Cash Receipts

Expected Cash Payments:

5.     Purchase Goods & Equipment

6.     Salaries

7.     Utilities

8.     Depreciation

9.     Rent

10.  Building Services

11.  Insurance

12.  Office Expenses

13.  Interest

14.  Sales Promotion

15.  Taxes & Licenses

16.  Maintenance

17.  Delivery

18.  Misc

19.  Total Cash Payments

Cash Balance:

20.  Beginning Month Cash Balance

21.  Cash Change (item #4 minus #19)

22.  End of Month Cash Balance

23.  Desired Contingency Cash Balance

24.  Short-Term Loans Required

25.  Available Cash- End of Month

Cash for Capital Investments:

26.  Available Cash- End of Month (line #25)

27.  Desired Capital Cash

28.  Long-Term Loans Required

 

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