One of the most important lessons business persons have to learn, often
painfully, is that cash really is king. Simply put, it doesn't matter how much
money is coming in the future if you don't have enough money to get from
here to there. Employees can't wait on wages until your customers pay.
Your landlord doesn't care that you're talking to investors and will have
the money in a couple of months. Suppliers may not be willing to extend your
credit any further and you may not be able to purchase the goods you need in
order to deliver to your customer and receive payment.
More businesses fail for lack of cash flow than for lack of profit. Why
is this? Two main reasons:
- Business owners are often unrealistic in predicting their cash
flow. They tend to oversetimate income and underestimate expenses.
- Business owners fail to anticipate a cash shortage and run out
of money, forcing them to suspend or cease operations, even though they
have active customers.
Its important to know the difference between profitability and cash flow:
Profit is the difference between income and expenses. Income is
calculated at the time the sale is generated, rather than when full payment
is received. Likewise, expenses are calculated at the time the purchase is
made, rather than when you pay the bill.
Cash flow is the difference between inflows (actual incoming
cash) and outflows (actual outgoing cash). Cash In is not achieved until
payment is received and Cash Out is not calculated until payment is made.
Cash flow also includes infusions of working capital from investors or
debt financing.
Cash flow is often calculated on a monthly basis, since most billing
cycles are monthly. Most suppliers will typically allow somewhere close to
thirty days to pay. However, in a cash-intensive business with a lot of
inventory turnover, such as a restaurant or dairy, it may be
necessary to calculate on a weekly or even daily basis.
How to Project Cash Flow
- Start with the amount of cash on hand - your current bank account
balance(s) plus cash on hand.
- Make a list of anticipated inflows - customer payments, collection on
bad debts, interest or investment earnings, etc. List not only the
amount, but also when it will be coming in.
- Make a similar list of anticipated outflows - wages, monthly
overhead, payments on accounts payable or other debt, taxes payable or
set aside for future payment, equipment purchases, marketing expenses,
etc.
Create a spreadsheet or other like analysis in chronological order
. If at any point
you have negative cash balance, or even a very small one, you have a
potential problem.
It's best to be extremely conservative, i.e., estimate inflows lower and
sooner and outflows higher and later. If you end up with a cash surplus, it
can cover you for an unanticipated cash shortage in the future, or be
invested in something to help grow your business - you won't have a problem
finding something useful to do with the money. On the other hand, if you end
up with an unanticipated cash shortfall, you can end up damaging your
credit, losing suppliers, having to cut employees, or out of business
entirely.
Track Your Actuals
Keep a copy of your forecast, but track your actual cash flow as well.
Comparing it to your forecast will help you realise where you have
mis-estimated or overlooked something in your planning. Past Cash flow
statements and future Cash flow projects are among the core financials you
will need as part of your business plan for potential investors.
