Cash (Flow) Really Is King

From Scott Allen,
Your Guide to Entrepreneurs.
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Understanding and managing cash flow can make or break your business

One of the most important lessons entrepreneurs have to learn, often painfully, is that cash really is king. I'm not talking about paper money -- I'm talking about cash flow. Simply put, it doesn't matter how much money is coming in the future if you don't have enough money to get from here to there. Employees can't wait on paychecks until your customers pay. Your landlord doesn't care that you're talking to investors and will have the money in a couple of months. Suppliers may not be willing to extend your credit any further and you may not be able to purchase the goods you need in order to deliver to your customer and receive payment.

More businesses fail for lack of cash flow than for lack of profit. Why is this? Two main reasons:

Business owners are often unrealistic in predicting their cash flow. They tend to overestimate income and underestimate expenses.
Business owners fail to anticipate a cash shortage and run out of money, forcing them to suspend or cease operations, even though they have active customers.

Let's start by differentiating between profitability and cash flow:

Profit is the difference between income and expenses. Income is calculated at the time the sale is booked, rather than when full payment is received. Likewise, expenses are calculated at the time the purchase is made, rather than when you pay the bill.

Cash flow is the difference between inflows (actual incoming cash) and outflows (actual outgoing cash). Income is not counted until payment is received and expenses are not calculated until payment is made. Cash flow also includes infusions of working capital from investors or debt financing.

Cash flow is often calculated on a monthly basis, since most billing cycles are monthly. Most suppliers will typically allow somewhere close to thirty days to pay. However, in a cash-intensive business with a lot of inventory turnover, such as a restaurant or convenience store, it may be necessary to calculate on a weekly or even daily basis.

How to Project Cash Flow

Start with the amount of cash on hand - your current bank account balance(s) plus actual currency and coin.
Make a list of anticipated inflows - customer payments, collection on bad debts, interest or investment earnings, etc. List not only the amount, but also when it will be coming in.
Make a similar list of anticipated outflows - payroll, monthly overhead, payments on accounts payable or other debt, taxes payable or set aside for future payment, equipment purchases, marketing expenses, etc.

Put it all into a spreadsheet in chronological order (our Inventors Guide has a monthly cash flow projection worksheet, or PlanWare offers a free basic cashflow planner you can use as a starting point). If at any point you have negative cash balance, or even a very small one, you have a potential problem.

It's best to be extremely conservative, i.e., estimate inflows lower and sooner and outflows higher and later. If you end up with a cash surplus, it can cover you for an unanticipated cash shortage in the future, or be invested in something to help grow your business - you won't have a problem finding something useful to do with the money. On the other hand, if you end up with an unanticipated cash shortfall, you can end up damaging your credit, losing suppliers, having to cut employees, or out of business entirely.

Track Your Actuals

Keep a copy of your forecast, but track your actual cash flow as well. Comparing it to your forecast will help you realize where you have misestimated or overlooked something in your planning. Past cash flow statements and future cash flow projects are among the core financials you will need as part of your business plan for potential investors. After a few months of tracking it, you'll also find it an indispensable management tool.