Let me explain. Profit and loss statements are often run based on accrual accounting. What this means is that revenue is booked when it is earned and expenses are booked when invoices are received. The actual movement of cash to and from your bank account may happen significantly later than the timing reflected on your profit and loss statements. Further, good profit and loss management has a lot to do with tax management. Depending on your tax situation at the end of the year, you may book some receivables or payables in December or January. These adjustments can confuse your understanding of your cash position. In accrual accounting, you also deal with accounts receivable or accounts payable balances that transfer over from last year. Further, equity raised or dept principle paid may represent movement of cash, but none of this activity shows up on your profit and loss statement. For this reason, you can have profitable years were you are borrowing money to pay bills or loss years were you have plenty of cash.
Having a good budget may give you some guidance, but I have found that a budget alone does little to help you understand the effect of your income and expenses on your available cash now, one week from now or six months from now. Use your budget to give you insight into how to set up a proper cash flow management system, but I recommend you not rely on a budget to help you understand how to manage your cash.
For most businesses, good cash management can be done through a simple Excel spreadsheet. The spreadsheet needs three main elements. First, I recommend a set of rows at the top of the spreadsheet listing your income sources. Each row in the income section should represent a client or other party that puts money in your bank account (income). At the bottom of your income sources, create a row representing the total of all income sources for that column. Next, create a set of rows for people to whom you pay money (expenses). List out each person or vendor you pay. You can lump big items like payroll or credit card payments into one group for efficiency. At the bottom of expenses, create a row with the total of all expenses, just like you did for income. Once you have your rows labeled, you should add column labels for every week for the next year. Although I recommend picking Monday or Friday as the date you choose for your labeling, any day of the week will do. At the bottom of the cash flow sheet, create two more rows. Row one will be the Total Difference, which is the difference between the income total and the expense total for that column. You can label the next row Cumulative or Total Cash. For the Cumulative row, you will add the Cumulative value from the last column to the Total Difference from the current column. For the very first week you can simply add the amount of cash in you bank account to the Total Difference in exchange for the Cumulative value, since you have no previous Cumulative amount. See below:
NOTES: This is a fictitious example of a cash flow spreadsheet. I have added some color coding to track certain activities. The orange color represents items that have been received or paid. Color coding these items is important in tracking what is actual and what is still pending. On the Cumulative line I have added a conditional setting to turn any cell purple when the balance goes below $1,000. Visually, this color coding allows me to quickly see any low points in my cash flow. The Balance column can be a place for you to put money due or owed that you are not ready to commit to the cash flow. For example, you may be performing work for a customer where you are unsure if or when you will get paid. You may want to put any unsure amount(s) in the Balance column to remind you of this potential income. You can then wait until the invoice is sent to move it onto the cash flow. Finally, I like to take notes on any item that may not be self explanatory (see the NOTES row). This allows any one viewing the cash flow to have a better understanding of what each cell means. This personally has saved me headaches when reviewing upcoming expenses or past payments that seemed unusual.
Good cash flow management requires understanding the impact of every income or expense on a weekly bases. Given that due dates for bills vary throughout the month, bills must be paid weekly. I recommend not going more or less granular than weekly. Using your budget, plug in all the items you have to pay over the next year. Be honest about everything you will have to spend cash on. Fill in the income sources you have. It is important to be conservative when listing income. I only put income on the cash flow when I feel pretty sure I know it is coming. Remember that this spreadsheet is not for impressing investors or others, it is to help you manage your cash. When building and maintaining your cash flow worksheet, be very realistic.
In the example spreadsheet I have provided above, you will notice my balance gets pretty low during some weeks. This is OK. Actually, it is the point of this entire blog. Your budget may tell you that you are going to make a lot of money every month. The reality, however, may be that you have one week out of every month where you are out of cash. Some companies may find that certain months during the year are very tight months due to yearly expenses that come due. All of your other financial management tools will fail to tell you when these short fails will happen and how bad they will be. This is why good cash flow management is super critical.
Hopefully you will see a Cumulative line with all positive numbers. Honestly, though most small business may always have negative Cumulative balances a few months out. During hard times, you may battle to keep your Cumulative balance positive on a month to month basis. It is critical to be OK with seeing negatives at some point in your cash flow forecast. Being very honest about what you have to pay and what money you feel certain will arrive will provide you the information you need to get very good at understanding what money to chase and who you should pay on a weekly basis. Further, you will understand the impact of each decision on your cash position now and in the future. You will also gain insight and visibility to yearly cycles in your business where cash becomes very tight.
ADDITION NOTE: Some business may draw on a line of credit to cover monthly or yearly lows. I recommend adding a row labeled Line of Credit to manage the money coming in and out of your line of credit. You can add a separate Expense line for interest paid or you can simply include that amount in your Line of Credit row. The goal of this spreadsheet is good continuous cash flow management, so don't worry about adding Line of Credit or Credit Card balances to this tool. The more complicated you make the spreadsheet, the less likely you will manage it well.
Even if you have no desire to learn the ends and outs of accounting, I highly recommend you learn good cash flow management. You may want to implement this system for both your company and your personal finances. If you keep up with the spreadsheet weekly, you should find it only takes a half hour to an hour a week to manage it. This may include deciding what bills to pay and paying them. Setting up the spreadsheet initially may take some time, but it is well worth the effort.
If you think cash flow management is simply an operational detail, you are wrong. Good cash flow management can be a huge energy booster for you and your company even in the hardest of financial times. Understanding the impact of your financial decisions can help keep you and your team stay calm or even get excited during challenging financial situations. Knowing that you are going to make it through a tough month and knowing that you will recover well shortly after a tough period can be a huge confidence booster. Simply knowing that you are in a tough spot can give you the knowledge you need to rally your team and overcome difficult periods with confidence.
On a final note, realize that it may be hard for your brain to comprehend why the numbers are what they are. Your budget may be telling you that the numbers just don't work, but your cash flow may show that everything is fine. You may show a loss on your profit and loss statement, but have plenty of cash. Avoid comparing or attempting to understand these discrepancies. Obsessing on these differences will only cause headaches. Use the tool for it purpose and only its purpose, cash flow management!
Best of luck in your cash flow management, and may all your Cumulatives be white;-)
