Your Cash Flow System
(Cash flow is not just about expenses!)
Purpose of this Idea: The purpose of this process is to understand how cash “flows” in and out of your business.
Result or Output: The output of this process is to create your version of a comprehensive cash flow system to accurately forecast your cash position up to a year in advance.
Why You Need This: If a business could only have one financial management report, the best choice would be a comprehensive cash flow plan. Positive cash flow outranks both sales and profitability in the hierarchy of entrepreneurial essentials. It is what keeps a company in business. And in terms of determining the value (equity) of your business, free cash flow is always at the top of desired information.
What do cash flow projections tell you?
• The amount of cash required to operate in the foreseeable future
• Sources of cash
• Where your cash goes
• When you might need a cash infusion
• When profit distributions can be made
• Help determine the most appropriate form of external financing
Understanding the cash flow in and out of your business is vital to your success. Your cash flow is the heartbeat of your business, and if you don’t know what is going on then you’re destined to fail.
Key Points: Cash flow is just the cycle of cash in and out of your business. The main objective of cash flow management is to track all the activities in your business that receive or disburse cash. In this process, we’ll show you how to:
• Create a cash flow statement, to accurately provide current cash position.
• Create a cash plan, to look into the future
• Effectively review these statements so you can make sound business decisions
The Cash Planning Process
To create our cash plan we’re going to go through four steps, and we’ll look at each one in detail.
• Step One: Identify your beginning cash position
This is the number you just came up with while creating your cash flow forecast. Your beginning cash position is the ending cash position from the month before.
• Step Two: Forecast Cash
Your cash receipts are going to come from three sources:
1. Cash from sales- This is whatever portion of your sales will be in cash.
To forecast cash from sales you’re going to start with your net revenue. Using past experience, project monthly sales and then predict any changes that might happen as a result of things that are coming up like aggressive marketing, market expansion, new products, etc. The more months you go back to calculate this the more accurate your projections will be.
You can also use the revenue projections from your operation budget for this. The only modification will be that you must figure out what percentage of the prior month’s sales were cash sales and what percentage were invoiced and went over to accounts receivable.
Remember, if you accept credit cards then these sales are considered cash, minus the credit card company’s fee.
2. Cash from account receivables- Some of your cash may come from collections from accounts receivable. If all your receipts are immediate cash you won’t need to calculate you’re A/R position.
You can also use past experience to project this number, and the further you go back the more accurate your projections will be.
You can also use your accountant or bookkeeper to help you in this. They can provide a history of your receivables collections.
If you don’t have historical records then you need to start tracking the percentage of people that are actually paying you each month.
You can use this very general rule of thumb to get you started:
60% pay in the first 30 days
30% pay by 60 days
10% pay by 90 days
Remember, this is very general, and your business might have very different percentages than this.
3. Other cash receipts- This includes non-operating income like interest you receive, tax refunds, rental income, or sale of assets. If you get income fairly regularly through these means then go ahead and forecast them for the months ahead. If not, then it’s best to skip this step altogether.
4. Forecast cash disbursements- You’re going to use your past bills to predict what you’re going to have to pay out in the future. To do this, you’re going to use your cash flow statements.
Look at your last three months’ cash flow statements (if you’re a seasonal business, then grab statements from the past year). Go line by line, adding up how much you’ve paid out in each area, and then predict, based on those numbers what you’ll be paying out in the future.
5. Calculate net cash flow- Your net cash flow is the difference between your anticipated cash receipts and expected disbursements.
6. Calculate cash position- Remember, you’re starting each month with your beginning cash position (which is last month’s ending cash position). Your new month’s cash position is your beginning cash balance plus (or minus) your net cash flow. This number is your cash position at the end of the month.
• Step Three: Monitor and Track Your Cash
Depending on your business and volatility, you’ll need to monitor your cash on weekly or monthly basis. Some conduct daily monitoring, but if you’re in a position where you have to be concerned daily about your cash then that suggests that you need to take more long-term action to secure additional cash.
This system would work best for weekly, bi-weekly, or monthly monitoring. If you pay your employees on a weekly basis, then you should track at least on a weekly basis.
Step Four: Decision Making
You want to be able to forecast what might be happening with your cash flow, and then take action to prevent a future problem. This is the whole point of tracking. By knowing exactly the ebb and flow of your cash you can decide if you need to get a line of credit secured for a future shortage, or if you should invest the extra cash into a 30-day or 90-day note to earn interest.
“Cash is the lifeblood of any business and it is much like oxygen, you can’t survive without it. Michael Gerber said, “I have learned the hard way that money – the food of a business – must be tended to constantly. Daily. By the hour is best. I have learned that in a Free Market System, money is a monstrously complicated thing.”
- Michael Gerber, E-Myth Mastery, “The Seven Essential Disciplines for Building a World Class Company
Your Cash Plan
Your cash plan is just like a budget. In fact, a cash plan is often called a cash budget. It plans your cash for the future needs of your business.
Effective cash planning can help you:
• Prevent shortages
• Clearly see strengths and weaknesses in your current systems
• Plan your cash so you can meet goals
If you use Quick Books, you should be aware that it is now set up to allow data to be exported to Excel. Thus if you set your Cash Plan up using the template provided you should be able to export your numbers from Quick Books into the Excel Spreadsheet to make this more automatic and less of a manual operation that requires you to remember and do so much work. If you need help on this we have access to a Quick Books expert who can help you set up this process for a nominal fee.
Here’s an example of what your cash plan will look like:
Online example went here
The trick to cash planning is to be conservative. Yes, you need to be as precise as you can, but if you have to estimate how much you’re going to bring in then do it on the low end. If you have to estimate payments, then estimate a larger payment earlier than you think.
Also, try and maintain a cushion of cash for unexpected things. How much of a cushion should you have? It’s hard to say. A lot depends on your specific business. If things are going well and your business is stable, then a cushion of 5% of your monthly disbursements would work. If your sales are wildly inconsistent then you might want to have 25% or more of your monthly disbursements on hand.
Remember, your business stops without cash so make sure you’ve got some put away for emergencies. You never know when you’ll need it!
Reviewing Your Cash Plan
The more experience you get cash planning the more precise you’ll get over time. Reviewing your cash plan every month will help strengthen your skills in addition to making you more familiar with the cash dynamics of your business.
Creating a cash plan variance report can really help you see quickly what’s going on financially with your business. Your variance report is similar to the budget variance report, and is used for the same purpose. It compares the most recent cash flow with your cash plan, and it has a column that shows the dollar as well as the percentage variances for each item. You’re able to see, at a glance, that your supply expenditures are down 10%, payroll is up 3%, and your net sales are soaring at 15% more than they were last month. It’s vital information that you need to know about the financial health of your business.
Although cash planning can seem like something only big or “cash strapped” businesses do, the fact is that all businesses need to plan their cash on a month-to-month basis. By effectively planning your cash and monitoring it monthly you can prevent disasters like not having enough to pay your suppliers, your employees, or your rent if you come up against an unexpected shortfall. You can juggle your expenses, if you have to, and effectively decide which bills need to be paid now and which ones can wait a bit.
Cash Flow Statement
Your cash flow statement is going to help you see how much cash you have on hand during a given time period. Usually, your cash flow statement should be run once per month, but if you’re growing quickly then once per week would be better.
Basically, a cash flow statement is a wrap-up of all the cash you took in during the period, how much cash you paid out to vendors, payroll, and other bills, and the difference between the two.
Building Your Cash Flow Statement
If you’re in business then you should have a business banking account, which logs all the money you have coming in and all the money you have going out. If you’re currently intermingling your personal funds with your business funds, then stop immediately! By keeping your personal banking and your business banking completely separate, record keeping is made much simpler and any legal ramifications are avoided.
Now, to create your cash flow statements you’re going to go through your business’s bank accounts and add up all the payments and receipts for each month in the past year. Get as detailed as you can here! Under your Utilities category, put exactly who you paid, for what, and for how much. Just creating one big number and lumping it under “Utility Bills” isn’t going to be very effective. The more detailed you get the easier it will be for you to understand what is happening with your cash.
The easiest way to do this is to use the same categories that your income statement uses. Non-cash items like depreciation will not be included in this tally, but things like loan principal repayments will be. Here’s a good example of what your cash flow forecast will look like:
Online example went here
Now that you’ve got a list of your outgoing payments and incoming receipts, simply add both lists up and subtract your payments from your receipts. This shortfall or surplus is your “net cash position” for the month. Your overall “ending cash position” is the amount of cash you have available at the end of the month. This amount will be your beginning cash position for the next month.
If you have a positive number, then great! If it’s negative, then we’ve got some work to do. Remember, the key to successfully managing your cash flow is accountability. You’re already taking an important step by looking boldly at what is happening in your business. Don’t get discouraged if it looks you have some hard work ahead. Even business giant Henry Ford had trouble managing his cash in the beginning. You can always learn and improve.
It’s important to note that unless you’re using the cash accounting method you will not have a very good feel for your cash needs and you might difficulty forecasting it.
How To Complete Your Cash Flow Forecast
The purpose of Cash Flow Forecasting is to help you see into the financial future of your company. Cash Flow Forecasting help you organize your expenses and income by categorizing everything coming in and going out, ensuring that nothing gets lost in the day to day shuffle.
It also allows you to prepare for a financial shortfall by giving you time to notify creditors and vendors. Because you can see what’s coming, you can prepare.
Thanks are due to Kevin DeLucenay for these wonderfully clear instructions on cash flow forecasting.
1. All individual non-total lines are in black, non-bold.
2. All income headings and totals are in black bold.
3. All expense headings; sub-totals and totals are in red bold.
4. All weekly cash available totals are in green bold.
5. All savings account and Total Cash Available lines are orange bold.
6. All individual expenses are entered in black, non bold until check is written for the expense.
7. When a check is written for an expense, the expense is changed from black to blue, to show that it has been paid.
8. When deciding where to put a bill:
a. If a bill is received from the same vendor more than three or four times a year, they should have a permanent line.
b. If a bill is received fewer than three or four times a year, that bill should be put under “misc.” This allows all bills to be tracked, but not have too many lines on the Cash Flow Forecast program.
9. The ending cash balance at the bottom of the sheet will need verified, and usually changed to match the balances in checking accounts. (Done weekly).
1. “Acct.#” This column is used for in-house account numbers of specific items.
2. “Account Name” This column is used for income and expense headings, and for individual incomes and expenses.
3. “Total Amt. Due” This column is the total owed, but not yet paid. As payments are made, this amount is deleted by the amount paid.
4. “Week End”columns. These columns are used for a week-by-week schedule for predicting cash flow in and out.
1. Operating Income. This line is used for all Operating Income. Income can be broken down into as many lines as needed.
a. Income source is not important, as this program tracks cash only, so only one line of total income per week is needed, if desired.
2. Total Op. Income-Forecast. This line is a total of all income forecast for the week.
3. Total Operating Income-Actual. This line is the actual total operating income.
4. Diff. of T.O.I. Act. VS. Forecast (%). This line is the difference, in a percentage, of forecast income vs. actual income. (T.O.I. = Total Operating Income) This is a formula, and will automatically be figured as actual income is entered.
5. Year to Date Act. Vs. Forecast. This line is a year-to-date running average of the actual income vs. forecast income.
a. This formula will need changed weekly (after the first two weeks).
b. The setting now is the average of the first two weeks.
6. All expenses can be put in one of three categories.
a. Variable Expenses. These are usually vendors, and other expenses that vary with income.
b. Fixed Expenses. These are expenses that do not vary with income, such as rent, utilities, insurance, etc.
c. Non-Operating Expenses. These are expenses that a buyer of the business may not occur, such as:
1). Interest Expense.
2). Research & Development.
3). Charity Contributions.
4). Above Market Rent and/or Salaries.
5). Business Development Expenses.
6). Travel Expenses.
7). One-Time Expenses (e.g. Tax Penalties, Fines, Accidents)
Note: Depreciation, Amortization, and Other Non-Cash Adjustments To Taxable Revenue Do Not Appear In A Cash Flow Forecast.
7. Total Variable Expenses. This is a total of all variable expenses, and is shown in bold red.
8. Gross Profit. This line is operating income minus variable expenses, and is shown in bold black.
9. Fixed Operating Expenses. This is a heading for all Fixed Expenses.
a. Payroll. This line is for all gross payrolls, not including payroll taxes.
b. Payroll Taxes. This line is for all payroll taxes, but not taxes paid by employees (withholding). Withholding is in the Payroll line.
c. Other Taxes. This line is for taxes not covered by payroll tax, such as sales tax, state withholding (because it is paid monthly), property tax, etc.
d. Advertising. This line is for all advertising expenses.
e. Communications. This line is for all communication expenses.
f. Utilities. This line is for utility expenses.
g. Insurance. This line is for all insurance expenses.
h. Shipping. This is for all shipping expenses. Shipping may be a Variable Expense.
i. Bank and Lease Payments. This line is for monthly payments. (Interest is actually a non-operating expense, but for cash flow management, it is recorded here).
j. Office Supplies. This line is for all office supply expenses.
k. Misc. This line is for items not applicable to other headings.
10. Total Fixed Op. Expenses. This line is a total of all fixed expenses.
11. Net Operating Income. This line is net operating income, (income minus variable and fixed expenses) and is shown in black bold.
12. Non-Operating Income. This heading is for any non-operating income, such as borrowed cash, sale of company property, company investments, or any other company income not derived from normal business operations.
13. Non-Operating Expenses. This line is for all Non-operating Expenses (see above).
a. Past Due. This line is for past-due expenses occurred before this cash flow forecasting is put into effect. (All expenses after that will be addressed elsewhere).
b. Interest. This line is for interest expense that is not in other lines, (e.g. line of credit interest payment).
c. Business Development. This line is for any business development expenses, such as worker training, officer education, travel, and any expense associated with education and training.
d. Savings Account Addition.
1) Add/Reduce Savings. This line is automatically figured at 2% of actual income from the Operating Income section above. This line is should be in effect until one month’s income is in a savings account in the form of cash. This formula can be changed if needed.
14. Tot. Non-Operating Expenses. This line is a total of all Non-Operating Expenses.
15. Total Income. This line is Operating Income, plus Non-Operating income.
16. Total Expenses. This line is a total of Variable Expenses, Fixed Expenses, and Non-Operating expenses.
17. Cash Available This Period. This line is how much cash is available from this week’s activities. This number may be positive, or negative.
18. Beginning Cash Balance. This is the cash balance (total from all checking accounts) at the start of the week. This figure is the ending cash balance from the week before.
19. Cash Available This Period. This amount is taken from the Cash Available This Period line three lines above this line.
20. Ending Cash Balance. This figure is how much cash is available this week in checking accounts. This figure is transferred to Beginning Cash Balance for the following week.
a. This balance should have a minimum balance allowed, depending on your business situation.
b. Change the Min. Req’d amount as needed
21. Savings Acct. Balance. This figure is derived from adding the previous week’s savings account balance and the “Total Sav. Addition/Reduction” line from the current week.
a. This balance should have a minimum balance allowed, depending on your business situation.
b. Change the Min. Req’d amount as needed.
33. Total Cash Balance. This figure is the total cash available to the company this week. It is a total of all checking accounts, and the savings account.
The first year of using this Cash Flow Forecasting is the hardest. After the first year, the previous year is used as a template. It is then much more accurate than the first year. After using this program, you will wonder how you kept records of bills and company cash before!