Cash is the “blood” that flows through a business. Without cash a business will die – no cash equals no business. Lack of cash is very common in business but it doesn’t have to be and it certainly does not have to be a disaster. You can’t always prevent a cash flow problem from occurring, but if you know when it is coming you have time to address the situation. If you are at a point where you are afraid of what you will find if you complete a cash projection, then you absolutely need to do one now!
STEP 1 – UNDERSTANDING CASH FLOW
It may sound simple but the first step in managing cash flow is understanding what cash flow really is. In basic terms it is the difference between cash coming in and cash going out. The real key however is timing – when cash is coming in versus when cash is being spent. It would be nice if cash flow was like a tidal flow – coming and going on an even and predictable schedule. Unfortunately cash flow is a little more complicated since it involves more pieces. Accountants define the cash flow cycle as the time between buying raw materials, converting them into inventory, selling your inventory, and finally collecting on those sales. The lag time between each of those steps is what causes an issue. The longer it takes to convert cash out into cash in, the more chance there is for a shortfall. In construction, the cash flow cycle is long and getting longer. Understanding your particular cash flow situation has become absolutely critical to your business survival. For your business to survive you have to make the commitment to do what it takes to never run out of cash.
STEP 2 -KNOWING YOUR CASH BALANCE
Do you know your cash balance today? How do you know where you are going if you don’t know where you are starting from? The smartest business people will still make bad decisions if they have no information. Make it a priority to know your cash balance – it should be as familiar to you as your social security number!
Now don’t say, “That’s easy. I’ll just call the bank.” Your cash balance is not what the bank says you have. The bank doesn’t know about all the checks you have written, which ones have cleared and which ones are still outstanding. You need to know your adjusted checkbook balance. This means keeping your checkbook register up-to-date, not once a week, but every day. A lot can happen in one week. Without the correct information you can make too many bad decisions – promises that you can’t keep, or worse yet write checks that will not clear. There is no quicker way to ruin your reputation than by bouncing checks.
STEP 3 – GATHER THE INFORMATION
To prepare you cash flow projection you need to know where it is coming from and where it is going to. You do not need a crystal ball but you will need to do some educated guessing. The more thorough and realistic you are the better prepared you will be.
Estimating when you will be spending cash is relatively easy since it is starts with the bills you already have on hand. To figure out when you will be spending cash you need to look at an Accounts Payable Aging Report – a list of all the bills you owe and (most importantly) when. You also need to consider spending that you don’t have a bill for – payroll, quarterly taxes, and equipment maintenance. Get in a “worse case scenario mindset” – include every expenditure that “might” happen. A common cause of cash flow problems is being confronted by a sudden and unexpected expense.
Estimating cash coming in requires a bit more guessing, judgment, and conservatism. If you send bills to your customers, you can base it on when your customer’s invoices are due but bear in mind their individual payment history. If they always pay 15 days late, then you have to assume they will continue paying 15 days late and adjust the date you expect to be able to make a deposit. You may have to project the date of a closing to guess when you will receive final payment for a house. With any luck you have a production schedule that you can follow. The wildest guess will be for when you think a new customer will give you a deposit. The best way to estimate new deposits will be based on the very recent past. In the past 3 months, how many deposits did you get? Have those deposits been increasing or decreasing? You need to be honest and realistic when guessing about cash coming in – the worst thing you can do is fool yourself into believing that there is more cash coming in than there really is.
STEP 4 – CREATE A CASH FLOW PROJECTION
A cash flow projection is not as complicated as most people think. Preparation does not take sophisticated software or a staff of accountants. A cash flow projection is very similar to a checkbook. Your checkbook is a record of historical cash transactions. A cash flow projection is a record of future cash transactions. A cash flow projection starts with where you are today, adds what cash you expect to collect, then subtracts the bills you expect to pay. The result is the cash you expect to have at the end of the period. It is prepared for a period of time – monthly or weekly. When cash is tight, I prefer a weekly format as shown in Table 1.
|Beginning Cash Balance||$89,452.97||$98,300.20||$91,699.81||$103,760.23|
|Expected Cash Deposits||75,000.00||32,852.55||40,671.19||36,274.89|
|Bills to Pay||(66,152.77)||(39,452.94)||(28,610.77)||(136,149.77)|
|Estimated Ending Cash Balance||$98,300.20||$91,699.81||$103,760.23||$3,885.35|
In Step 3 you collected the information on your bills. In your Cash Flow Projection organize your bills by week based on the actual invoice due date (not how late you think you can pay a bill, but when it is really due!) With bills due, it is better to show them being due earlier rather than later. If you schedule a bill to be paid a week after it is due and you can’t make the payment you are already a week behind.
In Step 3 you also gave some thought to your cash coming in. In your Cash Flow Projection enter your weekly expected cash receipts. With cash receipts, it is better to enter them later rather than sooner. It is better to be pleasantly surprised by cash coming in early, than to be disappointed and unable to pay your bills because the cash came in a week too late.
STEP 5 – ANALYZE YOUR PROJECTION
Now that you have taken the time and effort to create a Cash Flow Projection, you have to use it. Look at the Estimated Ending Cash balance. Where does your cash start to get tight? Is there a time when your balance goes negative – where you don’t have enough cash? Table 1 is an example to show you a simple but useful format. It shows a weekly projection for 4 weeks. The cash balance started at $89,452.97 but by the week ending July 28, 2008 the cash balance has gone down to $3,885.35. This may be a problem. For my company I like to do a weekly projection for 8 weeks. I want extra time to be able to address a potential cash shortfall.
You will also want to compare your Cash Flow Projection to your actual checkbook results. How did your guesses compare with reality? What did you over or under-estimate? Use these differences to adjust and improve your guesses going forward.
Your Cash Flow Projection is like a blood pressure cuff for the lifeblood of your business. But just like a one-time blood pressure reading doesn’t tell you much, a Cash Flow Projection done once won’t give you much information either. To give you the best information in the timeliest manner, your Cash Flow Projection should be updated weekly. You can’t always prevent a cash shortfall but if you make the commitment now to prepare a projection and keep it updated, you will never be unpleasantly surprised by a cash crunch. Forewarned is forearmed. So make your Cash Flow Projection a top priority!
About the Author
Jennifer Elder CPA, CMA, CIA, CFF, CGMA, MS helps accountants advance their careers and organizations increase retention by developing powerful communication skills. Jennifer works with companies and their emerging leaders to increase employee engagement and client value by understanding personality styles, generational characteristics, and communicating clearly, concisely, and persuasively.
As a consultant and keynote speaker Jennifer is known for being energetic and enthusiastic. She has conducted seminars for the Fortune 500, the US Government, State CPA Societies, and CPA firms in 48 states and 5 countries. She is both a business strategist and an accounting expert who can make the complicated simple, practical and useful. She is a published author, writer for the AICPA’s CPE Direct, named a “2015 Woman to Watch” by the AICPA and MACPA, and been awarded Outstanding Educator by the AICPA for the past four years.
When not on the road teaching, she is either living on her boat on Chesapeake Bay or skiing the slopes of New Hampshire with her husband and two cats (no the cats don’t ski!)You can reach her at 410-231-1881, or email@example.com