Effectively manage your company’s cash flow

The cash flow statement is derived from the cash flow budget, which is a forecast of receipts and payments. The Budget shows whether there is enough cash available for expenses, purchases of equipment and goods. Cash flow also indicates whether external sources of cash are necessary. While many business owners think that profits are the most important financial component of a business, lack of cash is often the main reason for business failure. In fact, a company can be profitable; however, you do not have liquidity to pay your expenses. Therefore, effective cash flow forecasting, planning and management are critical to the success of a business.

Planning is short term (daily / weekly) as well as long term (monthly / quarterly / yearly) so that a business has the optimal amount of money available when needed. The Budget controls the flow of funds to your business to make the necessary payments, without maintaining an excessively high Balance. It is a management function because the efficiency, speed and effectiveness of moving money through a business allows the business owner to convert it into sales and income more quickly, resulting in higher profitability and minimized interest payments.

The cash flow statement can be complicated to develop and manage. Therefore, budgeting is a great place to start and is a very effective tool for managing your business cash flow. The budget has three main sections to manage:

1) Money to receive

2) Expected payments

3) When payments should be made

The monthly budget is the main cash flow format. We recommend working three months at a time and building your projected 12-18 month budget ahead of time. Each month should have a budget target and an actual column, and the budget should be continuous (as you complete a quarter, budget for another three months).

The first end result of the budget is the cash balance at the end of the month, which is calculated as follows:

Starting Month Cash Balance + Total Cash Receipts – Total Cash Payments

Simply put, a negative balance will require an increase in receipts, a decrease in payments, or accessing a short-term loan. The second bottom line is the cash available at the end of the month, which is calculated by subtracting the desired monthly contingency cash and the required short-term loans.

The third bottom line is the required cash for equity investments, which is calculated by taking the cash available at the end of the month and taking into account the desired equity cash and required long-term loans.

By effectively planning their forecast and managing the various key elements of the budget, a business owner can determine the correct amount of funds available, when needed. See the end of this article for a budgeting worksheet to help you forecast, plan, and manage your business cash flow.

With your budget in place, you can now effectively manage your cash flow needs. By using some numbers from your income statement and balance sheet, you can analyze your current cash situation and apply it to future analysis. It is important to understand the relationships between your financial statements to effectively manage, plan, and forecast.

David Worrell of Entrepreneur Magazine has some very helpful information in his article “Managing Cash Flow” (January 2009) on simple ways to use cash flow formulas to effectively run a business …

A couple of key formulas will help you predict and manage sales-related problems:

1) Average number of days to collect money from customers or days of pending sales (DSO):

(Accounts receivable divided by annual sales) x 365

2) The average number of days to pay your bills or Days Payable 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 invoices longer than your customers and cash will accumulate.

2) If DSO is greater than DPO and your customers take longer to pay their bills, then the money is going out of business.

3) When DPO is greater than DSO, the greater the difference, the more funds flow into the business and vice versa.

4) The difference between DPO and DSO, called Float, is the number of days of cash sales that go into or out of business each year. The equation is:

(Sales divided by 365) x Floating

a) As an example: a business with sales revenue of $ 1.5 million with only eight days of negative float will see $ 33,000 in cash come out. This problem can be exacerbated if the drop occurs during a pay cycle.

So how can negative cash flow be fixed? Well, it really is quite simple. A couple of options:

1) Collect accounts receivable from customers more quickly.

2) Obtain better payment terms from suppliers.

The combination of options one and two will exponentially increase your cash flows, putting much less pressure on your business operations and allowing you to more effectively manage profits.

Conclution

To effectively manage cash flow in your business, you need to understand the relationship between your cash flow statement, income statement, and balance sheet, and what these finances tell you. Budgeting is the first step in developing your cash flow statement, using the numbers generated through your profit and income statement analysis and your balance sheet. Budgeting is a great tool for managing and planning your cash flow levels (see an example of the cash flow budgeting worksheet below).

Example of monthly cash flow budget worksheet

[ Monthly Basis; Budgeted and Actual Columns ]

Expected cash receipts:

1. Cash sales

2. Collections of accounts receivable

3. Other income

4. Total cash receipts

Expected cash payments:

5. Purchase of goods and equipment

6. Wages

7. Utilities

8. Depreciation

9. Rent

10. Construction services

11. Insurance

12. Office expenses

13. Interest

14. Sales promotion

15. Taxes and licenses

16. Maintenance

17. Delivery

18. Various

19. Total cash payments

Cash balance:

20. Initial month’s cash balance

21. Cash change (item # 4 minus # 19)

22. Cash balance at the end of the month

23. Desired contingency cash balance

24. Short-term loans are required

25. Cash available: end of month

Cash for equity investments:

26. Cash available: end of month (line # 25)

27. Desired capital cash

28. Long-term loans are required