A recent edition of the Wall Street Journal contained the following article, “Credit Scare Spreads in U.S., Abroad, Loan Terms Tighten for Smaller Businesses; Recipe for Slower Growth.” I am not an economist but perhaps like you, I have noticed that “recession” has become an incessant beat. If most of the weathermen are predicting rain it might not be a bad idea to bring along an umbrella. Likewise, warnings of bad financial weather should encourage all businesses to closely examine their controls over cash flow (spending, collecting and borrowing).
What is cash flow?
Simply put, cash flow is the result of netting all sources of cash coming into the business against all sources of cash going out of the business. It is not uncommon for businesses to experience peaks and valleys of cash activity, as the alignment of cash coming into the business is not aligned with cash leaving the business. Much as cars need to have the tires checked and be realigned at certain intervals, so too does a business’s cash flow require watching and occasional realignment. For a quick financial history of your own company’s cash patterns, try tracking the deposits (cash sources) and paid checks (cash uses) from your corporate bank account/accounts over the last year.
What you need is a barometer.
There are useful financial ratios like the acid-test ratio, day’s sales outstanding, receivables turnover, to name a few, that help identify the need for cash management action. However, these ratios are largely based on historical information. What is needed is forward looking information. A cash flow projection highlights potential cash leaks, peaks and valleys and surpluses allowing the business owner to make proactive decisions.
So how is a cash flow projection done?
The most important thing is to do it monthly even if by hand. There are many financial programs that contain excellent cash flow budgeting modules. Even Excel spreadsheets work just fine. The basic structure of the projection worksheet is fairly common. It begins with the actual cash on hand and then adds the cash receipts of the business whether from cash sales, collections of receivables or cash supplied by lenders, owners or other investors. These two amounts then provide the total amount of cash available to the business to operate the business (pay operating expenses), make investments (buy new equipment or make acquisitions) and pay lenders, pay dividends or withdrawals for the owners or partners. When the above amounts are deducted from the total amount of cash available, the remainder is the projected cash on hand for each month. Once done, this analysis can be easily updated.
Your updated Cash Flow GPS
With new highway construction, it is not long before GPS software is out of date. Many commercial systems include continual updating. The completed cash flow projection provides the business owner with a continually updated 12-month map of his cash needs. Months that produce excess cash (positive cash flow) can be used to “fund” those months when there is a shortfall. Sometimes cash shortfalls are larger than expected or occur for a period of time (like the start-up of the construction season for contractors). When this happens, some form of financing is required whether from the owner or a lender. The projection allows the owner to plan for any required cash infusion. This can save interest costs and transaction fees. A solid cash projection also helps ensure that the business owner has the necessary financial resources to take on new work and replace equipment. The projection is a useful tool to demonstrate to a prospective lender the amount and timing of cash requirements as well as the prospects for future cash flow to make loan payments.
I am skilled at helping business owners manage their cash flow. Our consultants are trusted business advisors who are seasoned at assisting a company create cash flow projections. We can train your staff to use proven methods to project future sources and uses of cash. Cash excesses or shortages are usually somewhat predictable.