Know Your Business to Grow Your Business

Lori Kudish, President of LTL Financial Consultants, reports: Cash flow, cash flow, cash flow: this is the mantra you should be repeating to yourself as a business owner. Never take your eye off the ball when it comes to your cash position. Yes, profitability is very important and we will discuss that more in March, but understanding and predicting your cash flow is critical to the survival of your business.

Going through this exercise is especially vital if you are selling a product or doing project work over a long period of time. In these cases the cash cycle (the time from when you first spend money for inventory or provide services until you receive cash in hand from selling that inventory or completing a project) is longer and the business may be required to pay for components and inventory before payments are received for sales. All business owners regardless of the type of business should be looking at cash flow regularly
A simple equation for calculating cash flow is outlined below:

Beginning Cash Balance + Cash In - Cash Out = Cash Flow

Cash in: from cash sales, A/R collections and credit card receipts

Cash out: for payroll, monthly expenses (rent, utilities, telephone), irregular expenses (estimated taxes, insurance)

Cash In

Look at your last year’s sales and determine what changes you expect over the next year. Will you institute a price increase? Will your volume increase year over year? Calculate the expected sales for the upcoming year as follows:

Previous year’s sales + Expected Increase in sales (i.e. 20%)

If you expect volume to remain static, but are instituting a price increase the equation would be:

Previous year’s sales + Price increase (i.e. 5%)

If you are putting a price increase into effect and anticipate a volume increase (the best of both worlds!) the calculation would look like:

(Previous year’s sales + Volume increase (20%))Price increase (5%)

Divide the total projected sales figure by 12 if your sales are consistent throughout the year, or allocate them appropriately based on seasonality. Next, you need to analyze how you are actually paid for your sales. Is yours a cash and carry business where you have no delay in receiving payments? Or, do you extend credit (terms such as Net 15 or Net 30) to your customers? If you are paid immediately for sales, you can account for the cash flow from those sales in the month that they occur. If, however, you sell on terms you will need to spread the cash flow out based on how your customers pay. Be realistic here, there will always be that customer (or customers in this shaky economy) who extend the terms and pay in 45 days when their terms are Net 30.

Cash Out

To calculate all of your outflows for the cash flow statement, you will need to look back at your checking account ledger over the last year (if you have that much history) and make a list of all the expenses you have incurred. Some of these will be regular, recurring expenses and others only occur sporadically throughout the year. For product based businesses, manufacturing costs will need to be charted as well. Examples of each type of expense are listed below:

Recurring Expenses
Payroll
Rent
Utilities
Debt Service
Intermittent Expenses
Taxes
Insurance
Legal
Accounting
Manufacturing Costs (product businesses only)
Components
Manufacturing costs
Freight
Warehousing

List the recurring expenses monthly on your cash flow statement and plot the intermittent and manufacturing expenses where they occur throughout the year. Remember this is on a cash basis so take into account the trade credit you receive from your suppliers and list the payments in the month you have to actually pay out the cash for them.

Why is this important?

First of all, knowledge is power. If you can see a period of tight cash flow before you are in it, you can make adjustments. You have all of your expenses laid out right in front of you. Where can you reduce costs? Can you defer some expenses until you are in a better cash position? Can you negotiate longer payment terms with your vendors?

Also, seeing the cash crunch before it arrives allows you to arrange financing to get you through the difficult time. While small business lending is not anywhere near as available as it was 2 years ago, there is money to be had. You will be approaching the potential lender (hopefully a banker that you have an existing relationship with) from a strong position if you can present a cash flow statement which clearly identifies your needs and most importantly shows how and when you will pay the bank back.

If you do not take the long view of your cash position, you have taken away many of the options outlined above. If you have already incurred the expenses, you can no longer defer them. If you purchase from a key supplier without discussing the longer payment terms up front you may damage an important relationship. Finally, financing arrangements take time to negotiate and document. You cannot approach your banker on Monday and expect to have the funds in time to make payroll on Friday. Advance planning is essential.

LTL Financial Consultants offers “CFO in a Box” services. Working with you to regain financial control of your company, we combine solid financial background, commercial lending experience, and first-hand knowledge of the challenges facing a growing business.

You can reach Lori Kudish, President of LTL at: lkudish@ltlconsults.com


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