Few things will kill a business faster than lack of cash. Even once profitable businesses can fail when they run short of the cash they need to sustain operations.
Your responsibility as the business owner is to make sure the business has the cash it needs. The goal is to increase the cash coming in and to decrease the cash going out, which can be accomplished using a simple tool called a Cash Plan.
A Cash Plan is a cash flow statement that includes forecasts of receipts and disbursements expected in upcoming months. This is a crucial document that a business must develop and use to keep its cash flow healthy. A diligent business owner always knows their current cash position.
Here are some answers to common cash flow questions.
Q: How can a Cash Plan be created?
A: We don't recommend that you try to produce your cash reports with accounting software because of their inherent limitations. For example, even systems that can help you with cash flow forecasting tend to "hide" certain cells, and to project your bills on their "due date" (which is not necessarily when you will actually write the checks). What's more, they don't show the bills you haven't yet been invoiced for or entered into the system. Cash flow forecasting is best done using Lotus or Excel -- in other words, by your own "model." It may take a little while to set up, but once you have created the template, it'll simply be a matter of plugging in the updated numbers.
The timing of your cash flow statements and monthly variance reports should mirror your Profit & Loss and Budget Variance reports. Some companies require a more detailed look by profit center or a more frequent look at their cash position when their situation is a bit more sensitive. Our recommendation would be to complete the process as suggested, and then monitor it for three months. At that point, you can determine if that system is giving you what you need.
Start by tracking your cash flow on a daily basis and scrutinizing every day's receipts and every check you write. If you aren't already doing so, start compiling a 12 week cash projection and record the expenses you know are coming, along with the revenue you expect to receive in that time period.
It can be uncomfortable to look at your cash flow situation as it currently stands, but at least you'll have better information with which to decide which bills to pay now, and which you will pay later.
Q: If a budget and a Cash Plan mirror one another, what is the benefit in having the Cash Plan?
A: This question comes up periodically for business owners who produce their income statement on a cash basis. When you produce cash-based reports, they will look very similar to cash flow statements. However, there are some important differences.
A cash flow statement also includes items that are found on your Balance Sheet, such as loans taken by the business and principal payments made on a loan. These items should actually not show up on your income statement (unless you want to become the next Enron), but they can have a significant impact on your cash flow one way or another. Other examples of items that don't show up on your income statement, but do show up on a cash flow statement are:
- Paid-in capital (any cash investment into the business made by an owner or shareholder)
- Non-operating sources such as tax refunds
- Owner draw (if it's not expensed as a salary or dividend)
Remember, your income statement doesn't always give you the full picture; it only tells you whether or not you're making a profit. You need to create a cash flow statement on a regular basis to understand the overall financial health of your business.
Q: What is the relation between money in the bank and ending cash position on cash flow statement?
A: The cash flow in the bank (your bank statement) and your own cash flow statements will be different only because of differences in the timing of posting the transactions -- there will always be a delay between the time you deposit cash and the time the bank posts it.
For instance, if you have a large number of cash receipts at the end of the month, they would not be posted until the beginning of the next month at the bank. You might want to note the dates your bank uses for reporting.
If both you and your bank are on a "calendar month," you might also check your cash balance a few days after your receive the statement, to see if it more closely matches your balance (by calling an automated inquiry line, perhaps.)
Keep your eye on the bottom line
One of the hardest truths of business is that no matter how good your products are, or how well you serve your customers, or how satisfying your work is – none of it will matter unless you are generating consistent profits and positive cash flow.
The bottom line is that your business needs cash in order to operate. Determining your cash flow and creating a Cash Plan is not always easy, but it's absolutely necessary, and there is no better time than now to develop specific plans to put your systems in place.
If you want more help developing a cash flow plan, check out our guide on how to strengthen your financial systems.