How To Improve Your Cashflow #1

Cash is the lifeblood of any business. Without it your business will die 

Of all the reasons as to why businesses fail, insufficient cash flow is one of the most common. Often this is not due to the lack of actual business or the amount of sales being made but the mismanagement of the funds available. Every business has its differences, but the core principles are the same, cash is the lifeblood of your business, without proper cash flow management and planning your business will die.

Difference between profit and cash

It is important to understand that profit and cash flow are two different things. Many operators will tell you that it is possible for a business to generate strong profits but collapse because they have run out of cash. The easiest way to explain this is to imagine a business whose profit and loss statement showed that last year they made a profit of $50,000. What the profit and loss statement doesn’t show is that for the first eleven months of the year this business wasstrapped for cash and nearly went under as they only made enough sales to cover their costs. In the last month of the year they made a couple of large sales and this is what resulted in the annual profit of $50,000. Profit is the result of trade over a given period, cash flow is required to keep the business in operation by covering day to day expenses. This is why it is important to manage and understand how cash flows through your business.

What is a cashflow budget?

A cash flow budget simply records the amount of money that you expect to flow in and out of your business over a given time frame. It is a financial tool that will help predict the availability of cash in a business at any given time. Income and expenses are calculated monthly to help plan for any future short falls in cash.

How to construct a cash flow budget

A cash flow budget is based around a series of assumptions about the expected performance of the business in the future. These assumptions need to be realistic and supported by the most accurate data you have available. If you have access to previous trading results then the best place to start is last years sales and expense records. Allocate these results into similar months that they occurred last year unless you know they will change in the future.

You may want to increase sales to account for more growth or you may know that you made an unexpected sale/ expense in a particular month last year that was a one off. You could be looking at introducing a new product line or service, looking to buy a new piece of equipment or employ another person. These will all have an impact on the cash flow budget and are the type of things you should account for so that you can forecast as accurate a picture as possible. If you plan to use the information on your profit and loss statement understand that these have been prepared for tax purposes and will account for non-cash payments such as depreciation. This shouldn’t be included in a cash flow budget as you don’t physically make a payment for these things.

If the business is new, then you will need to base your assumptions on research, market expectations, contracts held, known expenses such as rent or compare other similar business results. The more information you can build into the picture the stronger the tool will be.

Some will say it is a good idea to have three cash flow budgets that account for the best, most likely
and worse case scenario. Computer spreadsheets allow you to quickly adjust scenariosand as you receive your actual figures for each month it is important that you fill these in so that you have an up to date position of the business. This will allow you to react as quickly as possible to any changes that may be required. Based on this the cash flow forecast should be a living document and not filed away and forgotten about. Used properly it is one of the most important business indicators and planning tools you can have.

Many people in business will have their accountant prepare their cash flow budget for them. There  is nothing wrong with doing this as long as you, the business owner, understand the information that your accountant has prepared. If you don’t understand the assumptions that your accountant has put into the cash flow budget, then you won’t be able to use it as an effective tool, and why would you pay to have it done if you are not going use it and just file it away? 

Want to learn more?

Please click on the links below to view our 4 part series on "How To
Improve Your Cashflow"

How To Improve Your Cashflow #1
How To Improve Your Cashflow #2
How To Improve Your Cashflow #3
How To Improve Your Cashflow #4