March 2005

ABCs of Accounting: Managing Cash Flow

Managing the cash flow of our family is something that we all start learning at an early stage of adulthood. Some of us are better at it than others. We save a little here or there for a few months so that we can have that special weekend away or throw a great birthday party for our child or a friend. It is critical that we manage this process successfully or we can find ourselves burdened by consumer debt or not able to provide the necessities of life for ourselves and our families.

But when it comes to managing the cash flow of your business, the process can be much more complicated but no less critical. One of the factors that predicts the success of a small business is how well the cash is managed and whether the owner is able to reinvest cash in the business. The latter is especially important because if no additional investment is made, there is little or no opportunity for growth.

So how do we understand and manage the cash flow process? We must identify and recognize the nature of the expenses that our business incurs. The nature of the expenditure would include whether the cost is fixed (office rent, copier rent, monthly telephone charge, etc.) or variable (inventory, office supplies, long distance). Some costs can be both. For instance, electricity may vary depending on the season or if a major project is underway, but there is a certain level of electricity that is necessary to run our work place under all circumstances. When we are looking at our cash flow, the fixed costs and the fixed portion of partially variable costs must be paid for each month or period. The variable costs should rise and fall with the level of activity of the business or other factors such as weather. These costs are where we can most easily cut back on a short term basis when our revenue or our cash collections are slow.

The next part of our cash flow that we must analyze is the revenue, which essentially consists of two parts. We must identify the revenue that we expect to earn and must also project when we anticipate the cash to be received. These may not be different if the business is operated on a cash basis although even credit card receipts will have some delay in being credited to the bank account.

With these things identified to the best of our ability, we are ready to project our monthly cash flow. First we will list our expected cash receipts. This can be done on a monthly or weekly basis. Then we will deduct our anticipated expenses remembering to estimate as closely as possible the amount of variable expenditures. The difference between these two is our monthly or weekly cash flow from operations.

But we still have one more step. We now need to include the payments that we must make for our business that are not on a monthly basis. This might include license renewal, sales tax deposits, insurance, ad valorem taxes, etc.. Think of the costs that occur only once or twice a year and when those costs occur. We must deduct these costs from the appropriate month on our cash flow schedule.

The process that I have described above can be tedious and time consuming the first time it is done, but the rewards are worth it. With this schedule and the updates that we continue to make, we can know when our cash crunches are likely to occur. We can know if we can afford to incur the costs of a large new customer or if we need to obtain financing to allow expansion of our business. We can’t be lulled into overspending when we have some cash in the bank because our cash flow statement will remind us that the estimated federal income tax payment is due the fifteenth of next month.

Completing the process above requires a little common sense, a little ability with numbers and a lot of love for our business. And as women business owners, we have these qualities in abundance.