The cash flow statement is derived from the cash flow budget, which is a forecast of receipts and payments. The Budget shows if there is enough cash available for expenses, equipment and purchases of goods. Cash Flow also indicates whether external sources of cash are required. While many business owners think of profit as the most important financial component of a business, lack of cash is often the number one reason for business failure. In fact, a business can be profitable; however, he does not have the liquidity to pay his expenses. Therefore, effective forecasting, planning and cash flow management are essential 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 company to make the necessary payments, without maintaining an excessively high Balance. It is a function of management 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, leading to higher profitability and minimizing interest payments.
The statement of cash flows can be a complicated financial statement to develop and manage. Therefore, the Budget is a great place to start and is a very effective tool for managing the cash flow of your business. The budget has three main sections to manage:
1) Money to receive
2) Expected payments
3) When payments are due
The monthly budget is the main cash flow format. We recommend working on three months at a time and building the Budget for 12-18 projected months in advance. Each month should have a budget target and actual column, and the budget should be ongoing (as you complete one quarter, budget 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:
Beginning Month Cash Balance + Total Cash Receipts – Total Cash Payments
Simply put, a negative balance will require an increase in bills, a decrease in payments, or access to a short-term loan. The second bottom line is the Cash on Hand at the end of the month, which is calculated by subtracting the desired Monthly Contingency Cash and the Short-Term Loans required.
The third final result is the Cash Required for Capital Investments, which is calculated by taking the Cash Available at the End of the Month and taking into account the Desired Capital Cash and the Long-Term Loans Required.
By effectively planning your forecast and managing the various key budget elements, a business owner can determine the correct amount of funds available, when needed. See the end of this article for a budget worksheet to help you forecast, plan, and manage your business’ cash flow.
Having built your Budget, you can now effectively manage your Cash Flow needs. By using a few numbers from your income statement and balance sheet, you can analyze your current cash situation and apply it to future analyses. It is important to understand the relationships between your financial statements in order to manage, plan and forecast effectively.
David Worrell of Entrepreneur magazine has some very helpful information in his article “Keeping Tabs on Cash Flow” (January 2009) on simple ways to use cash flow formulas to run a business effectively…
A couple of key formulas will help you predict and manage sales-related problems:
1) The average number of days to collect money from customers or days sales outstanding (DSO):
(Accounts Receivable divided by Annual Sales) x 365
2) The average number of days to pay your bills or days outstanding (DPO):
(Accounts Payable divided by Annual Sales) x 365
So how can DSO and DPO be applied to your business situation?
1) If your DPO is greater than your DSO, you can hold or float your invoices longer than your customers and cash will accumulate.
2) If DSO is greater than DPO and your customers are taking longer to pay their bills, then money is going out of business.
3) When DPO is greater than DSO, the greater the difference, the more funds flow to the business and vice versa.
4) The difference between DPO and DSO, called Float, is the number of days of cash sales going into or out of business each year. the equation is:
(Sales divided by 365) x Float
a) As an example: A $1.5M sales revenue business with just eight days of negative float will see $33,000 in money walk out the door. This problem can be aggravated if the drop occurs during a payment cycle.
So how can you fix negative cash flow? Well, it’s really quite simple. A couple of options:
1) Collect accounts receivable faster from customers.
2) Obtain better payment conditions from suppliers.
Combining options one and two will exponentially increase your flows, putting much less strain on your trading operations and allowing you to manage your earnings more effectively.
conclusion
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 financial data tell you. The Budget is the first step in developing your Cash Flow Statement, using the numbers generated through your Analysis of Earnings and Income Statement and your Balance Sheet. Budgeting is a great tool for managing and planning your cash flow levels (see a sample cash flow budget worksheet below).
Monthly Cash Flow Budget Spreadsheet 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 of goods and equipment
6. Salaries
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. Beginning Month 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 required
25. Cash available at the end of the month
Cash for Capital Investments:
26. Cash on Hand – End of Month (Line #25)
27. Capital Cash Desired
28. Long-term loans required