I have no idea who originally said it, but the following quote is an extremely important principle to keep in mind when running a business: “Turnover is vanity profit is sanity cash is reality”.
High turnover (i.e. the total income for a business) is obviously good for a business since it reflects a demand for the company’s products and services but if you cannot achieve a good margin on these, then paying for all the overhead expenses may be very difficult. Businesses need to generate profit so that they can reinvest, have cash to deal with the hard times and can share some of the proceeds amongst staff and/or shareholders.
However, according to Michael Flint (CFO and Systems Advisor and VentureCapital.org Mentor), 82 per cent of US businesses fail due to “Poor cash flow management skills/poor understanding of cash flow”: preferredcfo.com/cash-flow-reason-small-businesses-fail/.
Ironically, it is quite possible that although a business may be profitable, it may still fail by not being able to raise sufficient cash to pay creditors when required or pay significant freight costs if shipping goods and materials to customers.
So how do you manage cash-flow? The purpose of generating a cash-flow is to simply ensure that you don’t run out of cash.
Forecasting the amount of money a business needs over coming weeks and months is critical to ensuring that required payments can be met and the business can function effectively.
There are multiple ways to do this, but I recommend keeping it simple since if managing your cash-flow is tedious or complicated, chances are that it simply won’t get done. In some ways, developing a cash-flow is similar to creating a budget since both need to forecast money coming in and money going out and ensuring that there is something left over in each period, however there are some important distinctions between the two.
First off, cash is indeed ‘reality’ since a cash-flow is intended to show what will be in the bank account(s) over coming weeks and in order for this to be accurate, it must be reconciled with a bank statement at regular intervals.
You cannot reconcile a business Profit and Loss budget with a bank statement since a P and L is exclusive of tax and GST (so PAYG, IAS and BAS payments typically do not
get included) and purchases greater than $150,000 are depreciated as opposed to showing as an expense.
There are a number of cash-flow tools that you can buy (just try doing a Google search) that will assist with this, but simply using Microsoft’s Excel works very well.
You will need to determine how frequently your cash-flow forecast is done (weekly, fortnightly or monthly) and the frequency is often a function of how tight your cash position is.
The less cash you have spare, the more often this should be done (I know of some businesses that were doing this daily for a while!)
The starting point must be your bank balance, so you need to know what invoices and expenses have been paid up to that point.
When forecasting income, you need to know what payments are expected but there are two important points here: 1) don’t expect your customers to pay on time (so I recommend planning on receiving the cash later than your payment terms) and 2) factor in GST.
When forecasting expenses, you will also need to factor in GST and will also need to include other taxes such as PAYG, IAS and BAS. Obviously you need to ensure that income minus outgoings over each interval stays positive.
Things can get tedious if trying to forecast every expense item so instead I recommend forecasting just four key ones: Tax payments, salaries/wages, major purchases and other expenses.
Ian Ash is the managing director for OrgMent Business Solutions.
