Effective Cash Flow Management
June 20, 2010
The Cash Flow Statement is derived from the Cash Flow Budget, which is a forecast of cash receipts and payments. The Cash Flow Budget shows if decent cash is usable for expenses, equipment and goods buys. Cash Flow also indicates whether external sources of cash are necessary. While many business owners think profits are the most important financial component of a company, the lack of cash is oftentimes the biggest reason for business bankruptcy. In fact, a business may be profitable; yet, it doesn’t have the cash to pay its expenses. Therefore, effective Cash Flow Forecasting, Planning and Management are essential to a Company’s success and should be an integral part of a company’s Business Plan.
Cash Flow Planning is short-term (daily/weekly), as well as, long-term (monthly/quarterly/yearly) so a business has the optimum amount of cash on hand when askd. The Cash Flow Budget ascertains the flow of cash into your business to make necessary payments, while not maintaining an excessively high Cash Balance. It is a function of Management because the efficiency, speed and effectiveness of moving cash through a business enables the business owner to turn it over into sales and income more quickly, resulting in greater profitability and minimized interest payments.
The Cash Flow Statement can be a complicated Financial to develop and manage. Therefore, the Cash Flow Budget is a great place to start and is a very effective tool to manage your business cash flow. The Cash Flow Budget has three principal sections to manage:
1) Cash to be received
2) Expected Cash Payments
3) When payments are to be made
The primary cash flow format is the monthly Cash Flow Budget. I recommend working on three months (quarterly) at a time, projecting the budget 12 to 18 months in advance. Each month’s column should have a Goal and Actual sub-column so you can measure your projections with actual results. The cash flow budget should be on a rolling basis, meaning as you complete one quarter, then you project another three months.
The first bottom-line for the Cash Flow Budget is the End of the Month Cash Balance, which is computed as follows: Beginning Month Cash Balance + Total Cash Receipts – Total Cash Payments
Simply put, a negative cash balance will require an increase in cash receipts, a lessening in payments, or accessing a short-term loan. The second bottom-line is the End of Month Available Cash, which is measured by subtracting the Monthly Contingency Cash sought after and Short-term Loans Required.
The third bottom-line is the Cash Required for Capital Investments, which is calculated by taking the End of Month Available Cash and factoring in Desired Capital Cash and Long-Term Loans Required.
By effectively Planning your Cash Flow Forecast and Managing the various key elements of the Cash Flow Budget, a business owner can construe the right amount of cash available, when needed. Please refer to the end of this Article for a Cash Flow Budget Worksheet to assist you in Forecasting, Planning and Managing your Company’s Cash Flow.
Having constructed your Cash Flow Budget, you can now effectively manage your Cash Flow needs. By using some numbers from your Income Statement and Balance Sheet, you can analyze your present cash situation and apply that to future Cash Flow analysis. It is important to realize the relationships between your Financial Statements in order to effectively Manage, Plan and Forecast Cash Flows.
Predict and Manage Sales Related Cash Flow Issues
A pair Key Formulas: the DSO and DPO
1) The Average number of days to collect money from customers or the Days Sales Outstanding (DSO): (Accounts Receivable divided by Annual Sales) x 365
2) The Average number of days to pay your bills or Days Payables Outstanding (DPO): (Accounts Payable divided by Annual Sales) x 365
How can the DSO and DPO be Applied to your Business?
1) If your DPO is greater than your DSO, you can sway or float your bills longer than your customers do and cash will accumulate.
2) If DSO is greater than DPO and your customers are slower in paying their bills, then cash is departing the business.
3) When DPO is greater than DSO, the bigger the difference, the more cash is flowing into the business and vice versa.
4) The difference between DPO and DSO, termed the Float, is the number of sales days in cash that is flowing in or out of the business each year. The equation is: (Sales divided by 365) x Float
a) As an example: A $1.5M Sales Revenue business with only eight days of negative float will see $33,000 in cash flow go out the door. This problem can be compounded if the drop happens during one payment cycle.
How Can You Fix A Negative Cash Flow?
Well, it is really pretty simple. A couple options:
1) Collect receivables more quickly from customers.
2) Obtain better payment terms from suppliers.
Combining options one and two will exponentially increase your cash flows, putting much less strain on your business operations and allowing you to manage more effectively for Profits.
Conclusion
In order to effectively manage Cash Flow in your business, you must understand the relationship between your Cash Flow Statement, Profit and Loss Statement and Balance Sheet, and what these financials are telling you. The Cash Flow Budget is the first step in developing your Cash Flow Statement, utilizing the numbers generated through your Profit Analysis and Income Statement and your Balance Sheet. The Cash Flow Budget is a great tool to manage and plan your levels of Cash Flow (please see an example Cash Flow Budget Worksheet below).
Monthly Cash Flow Budget Worksheet Example
– Prepare on a Monthly Outlook Basis with Budgeted and Actual Columns
Expected Cash Receipts:
Cash Sales
Accounts Receivable Collections
Other Income
Total Cash Receipts
Expected Cash Payments:
Purchase Goods & Equipment
Salaries
Utilities
Depreciation
Rent
Building Services
Insurance
Office Expenses
Interest
Sales Promotion
Taxes & Licenses
Maintenance
Delivery
Misc
Total Cash Payments
Cash Balance:
Beginning Month Cash Balance
Cash Change (Total Cash Receipts minus Total Cash Payments)
End of Month Cash Balance
Desired Contingency Cash Balance
Short-Term Loans Required
Available Cash - End of Month
Cash for Capital Investments:
Available Cash- End of Month
Desired Capital Cash
Long-Term Loans Required
About this Article Writer
Frank Goley is a business plan consultant, business consultant and business turnaround consultant for ABC Business Consulting. Frank is an expert in writing, developing and implementing business plans, business turnaround plans, business funding plans, marketing plans, strategic plans and web marketing plans. Frank offers comprehensive business consulting, business coaching, business turnaround consulting, along with web seo, web development and web marketing consulting, to small and medium size companies.. Frank is author of the business plan book, The Comprehensive Business Plan Workbook – A Step by Step Guide to Effective Business Planning, and he has over 50 published articles on business success strategies. He also writes the Business Success Strategies Blog.
Posted by admin under Uncategorized |