How To Avoid a Cash Flow Crisis

Why is Cash Flow hard to understand?

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How To Avoid a Cash Flow Crisis

Why is Cash Flow hard to understand?

Profit does not equal cash flow. This is the first concept to understand.

I often call the Statement of Cash Flows the forgotten financial statement.

Most business owners don't look at it, many accounting professionals simply ignore it.

Yet, many business owners run their business based on bank balances, you understand cash comes in, and cash goes out, but many don't understand how that relates to the Profit & Loss and Balance Sheet.

When we monitor our historical cash flow, we have a clear view of what happened and where we came from.

And one step further, with cash flow forecasting, we have visibility into what is coming so we can make decisions and plan ahead.

According to Intuit’s ‘State of Small Business Cash Flow’ report, 61% of small businesses regularly struggle with cash flow and 69% of their owners have been kept up at night by cash flow concerns.

How does a cash flow crisis happen?

A cash flow crisis usually has symptoms that occur before the crisis.

Here are a few red flags to watch for.

1. Using personal funds to pay for business expenses

2. A growing credit card balance month after month

3. Taking on more debt (loans, lines of credit) to pay for operating expenses

4. Hesitation in paying vendors because those funds are needed for payroll

5. Not paying yourself

6. Not paying sales tax

7. Not paying payroll taxes

Why do business owners struggle with cash flow?

Traditional financial reports (Profit & Loss statement, Balance Sheet and Cash Flow statement) can be difficult to interpret and don’t tell the whole cash flow story.

“Reviewing the traditional reports monthly works for measuring performance against budgets and benchmarks, but you can lose sight of important activity (and miss out on opportunities) if you rely solely on monthly financial statements.”

Focus on cash flow to avoid future cash flow problems

Ideally, you should focus on cash every week.

How to Run a Cash Flow Meeting

1. What happened to cash?

Review the past week’s cash activity, was this in or out of line with expectations you had last week?

2. What is the cash balance right now?

Understand your cash balance today, across all bank accounts and credit card balances.

Review accounts receivable, what is due in the coming week, who is late?

Review accounts payable, what is due in the coming week, is anything overdue?

Review upcoming debt payments.

3. Where is our cash going in the next 4 to 12 weeks?

Based on what happened last week, where you are today, and your knowledge of upcoming events, forecast expected cash inflows and planned cash outflows for at least the next 4- 8 weeks.

Focus particularly on the next 1-2 weeks, so you know what needs to be addressed immediately. Many businesses take this a step further and have a rolling 13 week cash flow forecast at all times, running different scenarios based on of this so they have a base case, best case, and worst case lined up

Reviewing your cash flow should become part of your weekly habits.

At the end of this process, you should be confident in knowing:

1. I understand where my cash came from and where it went last week

2. I know how much cash is in the bank today, and if there are any critical unpaid bills or open invoices outstanding from customers that need action NOW

3. I have an expectation of upcoming cash inflows, cash outflows, and my resulting cash balance for at least the next 4 8 weeks

4. I have a list of action Items to help make that cash flow forecast a reality (customer follow ups, payments to vendors, purchase decisions, etc.)

Cash Burn Rate

The cash burn rate is the rate at which a business uses cash. Cash burn rate is always negative since it does not include cash inflows from sales, debt, or investments.

Knowing your cash burn rate answers the following questions,

Are your current operations sustainable?

How long can operations continue with no cash inflow?

Putting it all together

Creating a cash flow forecast should be approached like a budget. It is meant to be a tool to know how the business is doing.

Just like a budget, comparing the forecasted cash flows to what actually happen is important.

This allows, if needed, adjustments to be made to the model.

Don't let fear and stop you from getting control over cash flow.

James Fleming III, EA

Sentinel Tax & Accounting