Have you ever had a situation in your business where you did not have enough money to cover all of your costs for the week, but thought you did? Or, have you ever had "extra" cash and didn't know what to do to manage the money effectively for the future?
These are common problems for many small businesses like yours. Even big businesses have these same problems; only they have to deal with a lot more zeros. There have been businesses that have shown millions of dollars in profit, but have failed miserably. Do you see any F.W. Woolworth's around any more? Chrysler almost went under for the same reason. And now look at Enron or WorldCom. No matter what the size of your business or how much profit you are making, managing the lifeblood in your business—cash—is the most important aspect of any business.
I'm sure some of you are saying to yourselves right now, "Wait a minute, I thought profits were the most important thing in a business?" This is a common misconception; however, although making a profit is important, profit comes after good cash flow management. The reason that profit often takes the spotlight is because of the accounting method you probably are using, called accrual accounting.
Accrual accounting is a method of accounting that recognizes income when it is earned and expenses when they are incurred, regardless of when cash is received or disbursed. What this means is that you show sales on your income statement the moment you transfer ownership of your product or service—those new wood floors, for example—to your customers. Does this mean you have received cash from the customer for this transaction? If it is a cash sale, you have; however, if it is a credit sale, you haven't. As for expenses, you show them when you get the bill for something. But, do you pay your bills immediately upon receipt? Probably not.
Let's take a closer look at the method of accrual accounting. Accrual accounting uses an income statement that is helpful for managing your expenditures and pricing your products or services. It also is useful for projecting your monthly sales and expenses in a budget. A budget lets you know how well you are balancing your expenses in comparison to your sales.
With a budget in place, the next step in accrual accounting is to identify your expenses by variable and fixed categories. A variable expense is one that changes with sales, such as the cost of the finish you are applying, shipping costs of the products, employees' wages, etc. The fixed costs are the expenses that stay the same, no matter what happens to the level of your sales. Once you have identified your variable and fixed costs, you can use the information to determine the level of sales you need to cover all the costs you currently have and also for pricing of your products. This is called breakeven.
This seems like a pretty complete picture; however, in addition to your income statement, you should be generating another statement called the statement of cash flows. This is the most important financial statement to watch. It tells you the situation of the lifeblood in your business. All the income statement tells you is that you sold your products or services for more than your expenses (profit), or you had more expenses than sales for the month (loss). Even a small flooring business like yours can be hampered in growing properly if you don't have a good handle on your cash flow. The procedure to resolve cash flow problems is the same, no matter how big you are. This simple technique will give you advance notice of any cash flow problems and will allow you to take action to remedy the situation before it gets out of hand.
Although the method for calculating cash flow projections is simple, to do the projections correctly takes time. You may feel that you can't find the time to do it. But, what is the alternative to not taking the time to manage your cash flow? Not being able to pay a bill when it comes due—or maybe even worse.
Many of you probably sit down to the dreaded task of paying your bills at the end of the week. You see all of them sitting in a pile ready to be paid, and you wade through them to determine which need to be paid right away. Your heart races as you add them up and look at the balance in your checkbook. Are you shocked? Or well pleased? If you're shocked, then you may be asking yourself, "Do I pay my employees first, or the suppliers?"
This does not have to happen if you institute this simple procedure. It avoids all the headaches and stress you feel when the checkbook balance looks grim.
When you have a small business, you can use cash flow projection to better manage the peaks and valleys of cash flow. When you have a high cash week, you can put the money aside to cover the low cash weeks. Using this method also can be very useful in managing the cash flow on specific projects.
Cash flow projections can be developed very easily on a spreadsheet program on your computer. If you are not using computers, you can create your own form using the figures shown and make the calculations by hand. There are two spreadsheets you must fill out. The first one is a short-term projection of your cash needs, and the second is just an extension (longer term) of the first.
The first projection you will need is a statement of cash flow for six weeks out. Generating this statement is a simple process, but it is amazing how many companies don't do it. You begin by entering in your beginning account balance for the first week, adding in the first week's anticipated income, and subtracting the week's expenditures. This gives you an anticipated cash balance at the end of week one (see Figure 1). Then, you move week one's ending balance to the beginning balance for week two, again adding in the anticipated income for week two and subtracting week two's expenditures. The resulting number is the ending balance for week two.
Keep doing this for six weeks. Once you complete this process, you will be able to look at the bottom figures and determine if you will have a deficit in your cash situation during any given week. If a deficit is shown, plans then can be made to either increase your income (or lower your expenditures) until the weekly balance is at least a zero. If you have a cash overflow in any given week, you then will know how much you can put away to cover future low weeks.
In reality, it is important to break your expenses down into specific categories, so if there is a cash shortage in any week, you can determine if there are any expenditures (payments) that can be delayed. In the example in Figure 1, we would be short by $3,447.71 in week two. To solve this problem, you would need to work on increasing your receivables from past sales by calling late-paying customers. Or, you would need to increase your cash sales by at least this amount. If this is not possible, then you need to look at the anticipated expenditures for week two and determine if there are any that could be put off for a week or two.
As an example, you may need to pay $12,633 to your distributor for the week. But if you do, you will be short. Also, you can notice that in week three you will have more than enough to pay them. All you have to do is call the distributor and tell them your situation—based on your cash flow projections, you will be able to pay them the following week. Most vendors will work with you without any problem. However, if you don't call the vendor and just pay your bill late, you could hurt your chances for getting more credit with that vendor in the future. Most vendors will agree to a short delay if you call them before the bill is due. Also, you can delay paying other bills one week, and that should give you the help you need.
Another way to alleviate low cash periods is to pay your sales people on collected sales, not just sales. Paying on collected sales gives salespeople their commission for cash sales in the current week's paycheck and their commission for credit sales when the customer makes payment. That way, the salespeople also are motivated to find good quality, paying customers. I have seen some salespeople rack up sales and get paid on them, but the quality of the customer is not good. You should be doing a credit check and should establish a system forgiving credit.
Now that you have learned how to do cash flow projections for the next six weeks, you need to update this chart on a weekly basis. So far, these numbers are projections based on your best guess. At the end of week one, you need to plug in actuals, or exact figures, for that week. Then, recalculate all of your weekly beginning and ending balances. This will give you notice of any changes to cash balances for weeks in the future. Here is where a computerized spreadsheet comes in handy. Again, if you determine there is a deficit in any one week, you need to make plans to solve it.
When you get to filling in the third week's actuals, you will need to redo the form for another six weeks out. This will allow you to always have four weeks advance notice of any potential cash problems. This may seem like a tedious job, but it will make the difference in solving your cash flow problems and possibly keeping your business alive and growing strong.
Once you get in the habit of doing these projections on a weekly basis, you will find something amazing happening—your cash situation automatically will get better! When looking at your cash and analyzing it on a regular basis, you can get everybody on your team involved. Challenge your employees to see how you can improve week to week.
Now that you have learned how to do this for a six-week period, the second step is generating a spreadsheet for the coming 12 months (see Figure 2). It is easier than you think, because you probably have recurring monthly bills. These projections will be very important to help you manage the quarterly ups and downs of your business.
Also, this type of monthly information is what a bank will want to see if you are trying to get a loan. You will have to show them the anticipated payments in your monthly cash projection and how it will affect your cash flow. Also, a 12 month projection will help you determine how much of a loan or line-of-credit you will need. As you can see in Figure 2, you would need to have a plan in place to handle the June and July shortages. But, doing the projections gives you six months in which to make arrangements to meet these future needs.
Looking at Figure 2, you will see that in the months of February through July you have a negative cash situation, but in the months of August through January you have a positive situation. Unless you have lots of cash lying around that you can put into the business in these negative cash months, you will need to meet with a banker to discuss a line of credit. All you have to do is show them your cash projection and how you will pay them back. The most you would need, based on these projections, is $5,500.
If you are doing long-term projections for future growth, you can use the same method. This will help you to decide if you can take on some major expenditures and if you will be able to pay for them, either in cash or payments on a loan. Additionally, some of you may be working on large projects for extended time periods, and this method will help manage cash flow for the project. You would use the same format for all the income and expenditures on the project.
Once you get in the groove of doing these projections all the time, it becomes second nature, and you will reap valuable benefits. Remember: Managing your cash flow is more important than making profits. If you are selling your products or services for a good profit but are not staying on top of your accounts receivable, you won't be able to pay your bills. Think of this analogy: Everybody knows that Arnold Swartzenegger is a very strong and healthy guy (your profits). But, what happens to him if he gets in an accident and loses all his blood (cash flow)? He dies. So can your business if you are not watching your "business lifeblood" closely. Take advantage of this simple method to keep your business healthy and strong.
