The Cash Flow Control Guide

“John, one of the biggest truths about business is that net income or profit does not necessarily equate to having cash to pay the bills.”

“Well holy crap,” John said. “You’re telling me even if I make a profit I might not have the cash? How the hell does that happen?”

“Remember the difference between accrual basis and cash accounting?”

“Well yeah, I …”

“Well, if as a contractor, you spend all of your cash on materials in January for a job that will not be completed and paid for in March, you might show a profit in January but not have cash.”

“Well, I’ll be,” John said.

“John, cash flows in and out of a business and in order to really have control over the flow, you have to be forecasting and monitoring your cash flow and be ready to shore up any gaps.

“What follows is the Cash Flow Control Guide to help you get hold of the cash in your business.”

The Cash Flow Control Guide

Outline

1. Determining Financial Needs

2. Prepare Sales and Expense Forecasts

3. Prepare Income Projections

4. Prepare Cash Flow Projections

5. Use the Cash Flow Budget and Deviation Analysis

6. Control Receivables and Inventory

7. Managing Positive Cash Flow

What are your sales goals?

The revenue goals for the coming years should be an accurate projection grounded in reality. Set a stretch goal but make it realistic. Remember to be specific and answer how much and by when?

What are the expenses?

Expenses are typically easier to forecast than revenue. For example, you can get an insurance quote and know spot-on what your monthly insurance expense will be. Pick out a commercial rental space, ask the realtor “how much” and you will know your monthly rental expense. In order to project the future expense level, inflate them by the expected level of inflation.

Income Statement Data
Sales (Income)		$20,500
Cost of Sales (COGS)		$9,328
Gross Profit		$11,172
Gross Profit Margin		54.50%
Payroll / Wages / Salary		$2,153
Rent		$4,650
Depreciation		$3,000
Interest Expense		$1,250
Net Profit before Taxes		($765)
Adjusted Net Profit before Taxes		($765)
Net Profit Margin		-3.73%
EBITDA		$3,485
Net Income		($765)

Figure 12-1

If you are seeking financing then five questions must be answered:

1. What do you need the loan for? (Working capital? New equipment? In other words what type of asset will secure the loan?)

2. How much is needed?

3. How will the money be repaid?

4. When is the money needed?

5. What kind of financing is most appropriate for the business and why?

The Basic Rule in Financing Is This:

Match the term of the loan to both the term of the need and source of repayment.

Five Types of Financing

1. Startups – a combination of invested capital and long-term debt. Capitalization needs are detailed in the income and cash flow projections. The balance to debt equity is important. Too much debt early on is a bad deal.

2. Working Capital Shortages – After initial capitalization, working capital is generated from operating profits over a long period. If you suffer from chronic working capital shortages due to undercapitalization but are making some operating profits, then the answer may be a short term loan. But you must show the loan can be paid back and will increase operating profits. Quite often a modest working capital loan will put a business over the hump and give you breathing room to reach higher operating profits.

But remember, a working capital loan, which is paid back monthly over a period of three to seven years, adds substantially to your overhead costs.

3. Equipment and Other Fixed Assets – Typically secured by the equipment. A rough guideline: You can finance equipment with a useful life of 10 years up to 70% of its life and for as much as 90% of its value.

Don’t buy fixed assets on short terms.

4. Inventory, Seasonal Progress – short-term notes tied to a clearly defined source of repayment.

5. Sustained Growth – Sometimes growth can outstrip working capital. A business anticipating fast growth should also anticipate a lot of danger.

As sales go up, liquidity goes down. Sales don’t turn to cash as fast as suppliers need to be paid. As you add staff, productivity plummets. New larger space is needed with more administrative burden and increased fixed costs. It is inevitable.

The usual solution is a combination of new invested capital, lines of credit tied to receivables and inventory and long term working capital loans.