Manage Your Small Business Cash Flow More Effectively

Manage Your Small Business Cash Flow More Effectively
Angie Mohr CA CMA
www.numbers101.com

Understanding the flows and ebbs of cash in your business is critical to scouting for warning signs of impending cash crunches. Bookkeeping software like QuickBooks can tell you that you will be getting money in the door, but without knowing when, you're going to be left not knowing if you can pay the bills.

The activities that your business carries out can be broken down into several events. For a manufacturing business, these main events would be:

· Buying the raw materials
· Paying for the raw materials
· Manufacturing the product
· Selling the product
· Collecting cash from the customer

The events for service and retail businesses are similar. For ease of presentation, we will use a retail business in our examples.

Let's have a look at a simple example:

One day, you purchase inventory for your store for $100. You pay the bill to the supplier 30 days later. After 15 more days, a customer buys the product for $125. Your customer buys on credit so she does not actually pay you for another 45 days.

So, you know you're making a profit on the sale, however, you may miss the fact that it is a total (in this example) of 90 days between the inventory coming in the door and going out the door (the inventory holding period) and it is a 60-day span between cash going out the door and cash coming in the door (the cash float).
Why do we need to know the inventory holding period and the cash float? Because, we need to make sure that we can pay for the inventory when it's due. There's a 60-day cash flow gap between us paying suppliers and customers paying us. Now that we have that information, we need to ensure that we have the financial resources to "float" that inventory.

The Cash Flow Report

One way to pull all this information together is to prepare a Cash Flow Report monthly. This will let us predict the times when we will be short on cash and times when we will have extra cash that we will need to invest. If you have a bookkeeping program like QuickBooks, this will be an easy exercise.

The Cash Flow Report looks much like a budget, with the exception that it only cares about which period we will collect and disburse money.

Revenues

Let's just look at the revenue side for a moment. Our Monthly Budget Report shows us this information:

                   Jan      Feb    Mar      Apr   May   June
Revenue   1,250   1,095   2,470   1,750   975   1,645

Okay. So we know that we should be able to bill our customers those amounts. But what do we know about when we're going to get the money? We already know our average receivable turnaround time (refer to last month's column). If we get the money in on average in 37 days, is that enough information? Not quite.
We need to have an accounting of the percent of revenue we will receive in each month. We can do that by looking at our historical cash receipts and seeing what the patterns look like.

Let's assume the following: If we're looking at the month of March, we know that we will probably collect 15% of the March billings in that month. This tells us that 85% of all of our March revenues will be collected in the future. We know that we'll probably get 63% in the following month, in this case, April. This makes sense considering that on average we collect in 37 days. We have now collected 78% of all our March billings. A further 18% will be collected in May, and, assuming that we have no bad debts, the rest (4%) will be collected in June. Therefore, in June, we will be collecting 4% of March's billings, 18% of April's billings, 63% of May's billings and 15% of June's billings. We have now determined our expected cash inflows.

So, in May, even though we are billing $975, we are expecting to collect $1,737. You can also predict that June will have a significant bite out of its cash flow. Even though we billed a lot in June, we didn't in May and we are collecting 63% of May's billings in June. This is much more useful information for us as we now know what we expect to be in our bank account in any given month.

Expenses

The expense side of the Cash Flow Report is similar to the revenue side. We want to put expenses into the periods we expect to pay them, not the period to which they belong. So, for example, if we buy new stationary from our printer for $1,000 in May but we don't pay him until June, that expense would be in May on the Monthly Budget Report but in June on the Cash Flow Report.

Although, at first glance, it would seem onerous to track all of this information regularly, it is actually quite easy once you have set up the initial format. You can set up an Excel or Lotus spreadsheet to calculate your cash flows. Having an understanding of the money coming in and going out will give you better control over your business! (871 words)



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Copyright 2011 Angie Mohr