How to Plan Your Cash Flow

To be competitive, small business owners must plan and prepare for all future events and market changes.  Possibly the most important aspect of preparation is effective cash-flow planning.  Failure to properly plan cash flow is one of the leading causes for small business failures.

Experience has shown that many small business owners lack a general understanding of accounting principles.  For this reason, a few of the basic principles will be covered.

The Basics

Cash in business serves several purposes.  First, it is used for meeting normal cash obligations (i.e., paying bills).  Second, it is held as a precautionary measure for unanticipated problems.  Third, it is held for potential investment purposes.  The term "cash" refers to:

Cash

Checks

Checking Accounts

The Operating Cycle

The operating cycle can be defined as the system through which cash flows, from the purchase of inventory through the collection of accounts receivable.

It measures the flow of assets into cash and is, in effect, a "business stopwatch."

For example, the operating cycle may begin with both cash and inventory on hand.  Additional inventory is purchased on account to work as a cushion for future sales to guarantee that you will not deplete your stock.  Except for cash sales, when some of your inventory is sold, accounts receivable increase, but your cash doesn't.  Typically, you pay for the inventory you have purchased thirty days after it is received.  When the payment for inventory is made, both cash and accounts payable are reduced.  Thirty days after the sale of inventory, receivables are usually collected, which increases cash.  Now your cash has completed its flow through the operating cycle and is ready to begin again.

Current Assets

Cash and other balance sheet items which convert into cash within twelve months are referred to as current assets.  Typical current assets are:

Cash

Marketable Securities

Receivables

Pre-Paid Expenses

A Plan is Necessary

Cash-flow analysis shows whether your daily operations have generated enough cash to meet your obligations, and it shows how major outflows relate to major inflows.  As a result, you can tell if inflows and outflows from your operation combine to result in a positive cash-flow from operations or in a net drain.  Any significant changes over time will also appear. Understanding this will lead to better control of cash-flows and will allow adequate time to plan and prepare for the growth of your business.

It is best to have enough cash on hand each month to pay the cash obligations of the following month.  A monthly cash-flow projection helps to project funds and compare actual figures to past months.  It is important to project your monthly cash-flow to identify and eliminate deficiencies or surpluses in cash.  When cash-flow deficiencies are found, business financial plans must be altered to provide more cash.  When excess cash is revealed, it might indicate excessive borrowing or idle money that could be invested.  The objective is to develop a plan which will provide a well-balanced cash flow.

Planning a Positive Cash Flow

To achieve a positive cash flow, you must have a sound plan.  Cash reserves can be increased by:

Collection of receivables

Tightened credit requirements

Price of products

Loans

Increased sales

Collection of Receivables

Actively manage accounts receivable and quickly collect overdue accounts. Revenues are lost when a firm's collection policies are not aggressive.  The longer your customer's balance remains unpaid, the less likely it is that you will receive full payment.

Tightened Credit Requirements

As credit and terms are tightened, more customers must pay cash for their purchases, thereby increasing the cash on hand and reducing the bad debt expense.

While tightening credit is helpful in the short run, it may not be advantageous in the long run. Looser credit allows more customers the opportunity to purchase your products or services.  But, be certain that the increase in sales is greater than the increase in bad-debt expenses.

Pricing of Products

The primary goal of business is to make a profit.  Many small businesses fail to do so because they do not know how to price their products or services. Pricing is the critical element in achieving a profit as well as in maintaining positive cash flow, and is a factor all firms can control. 

Before setting your prices, you must understand your product's market, distribution costs, and competition.  Remember, the marketplace responds rapidly to technological advances and international competition.  You must keep abreast of the factors that affect pricing and be ready to adjust.

Loans

Loans from various financial institutions are often necessary for covering short-term cash-flow problems.  Revolving credit lines and equity loans are common types of credit used in this situation.

Increased Sales

Increased sales would appear to increase cash flow, but be careful.  For many companies, a large portion of sales are purchased on credit.  Therefore, when sales increase, accounts receivable increases, not cash.  Collection of receivables is usually 30 days after the purchase date, and sales expenses are most often incurred before receivables are collected.  When sales rise, inventory is depleted and must be replaced.  Because receivables have not yet been collected, a substantial increase in sales can quickly deplete a firm's cash reserves.  Again, by using a computer, you can maintain this critical data, as well as speed the time required to consider the "what if" concept.

Other Helpful Tips

Cash Reserve

You should always keep enough cash, as an added cushion for security, on hand to cover expenses.  But, it is unwise to keep more money on hand than is necessary to cover your obligations.  Excess cash should be invested in an accessible, interest bearing, low-risk account, such as a savings account, short-term CD or T-bill.  Keeping excess cash on hand reduces both the growth and the return on investment.

Projections

Good accounting records and projections are important tools for a small business.  Qualified accountants are necessary to help keep your records accurate and current.  However, you can reduce your accounting expenses by producing your own summary statistics and projections. 

Using A Personal Computer

With a personal computer, your business can have the added advantage of quick cash-flow projections as well as many other useful financial planning tools.

A good financial-management package and computer will enable you to review projected inflows and outflows of cash from month-to-month or year-to-year. By analyzing these projections you can see the fluctuations in cash flow and create management policies to avoid potential shortfalls.

There are numerous computer programs for making projections and keeping records and many advantages to having a personal computer for your business. The capabilities of modern computers are almost unlimited--they can aid in nearly every situation, from basic bookkeeping and "what if" analysis to inventory control or market demand projections.  While a computer is not a specific requirement to success for a small business, it is a business tool which in the future will separate the competitive from the  mediocre.

Compare your budget periodically with actual operations statistics. With effective records you can do this. Then, where
discrepancies appear you can take corrective action before it's too late. The proper choices for the ideal corrective action
depends upon your understanding of management methods in purchasing, pricing, selling, selecting and training staff, and handling
other management problems.

You're thinking you are able to hire a bookkeeper or an Accountant to deal with the record keeping for you. Yes, you can. But
remember two very important details:

1. Supply the accountant with true input. Should You Purchase something And don't record the sum in your business checkbook, the
accountant can't enter it. If you sell something for money and do not record it, then the accountant won't know about it. The
documents the accountant prepares will be no better than the info you provide.

2. Use the documents to make decisions. If you moved to a physician And he told you you were ill and wanted certain medication to
get well, you'd follow his guidance. Should you pay an accountant and he informs you your sales are down this season, do not hide
your head in the sand and pretend the issue will go off. It won't.

Business Management Roll in Personnel Selection. If your business Will be big enough to require external help, an important
responsibility will be the selection and coaching of one or more workers. You may start out with family members or business
partners to help you. But when the business grows - as you expect it will - the time will come when you must select and train
employees.

Careful selection of personnel is vital. To select the right Employees decide beforehand what you need each one to do.

Then search for applicants to fulfill these particular needs. In a small Business you will need flexible employees who can shift
from task to task as required. Include this in the description of those jobs you wish to fill. At the exact same time, look ahead
and plan your hiring to assure an organization of individuals capable of performing every essential role. At a retail store, a
salesperson might also do stock-keeping or bookkeeping at the outset, but as the company grows you'll need sales people,
stock-keepers and bookkeepers.

When the job descriptions are composed, line up applicants from whom To make a choice. Do not be swayed by customers who may
suggest relatives. In the event the candidate doesn't succeed, you might lose a customer as well as a worker. Some sources of
potential new employees are:

1. Tips by friends, business acquaintances. 2. Employment agencies. 3. Placement bureaus of high schools, business schools, and
colleges. 4. Trade and industrial associations. 5. Help-wanted advertisements in neighborhood papers.

Your next task is to display want ad responses and/or program Forms delivered by employment agencies. Some applicants will be
eliminated sight unseen. For each of those other people, the application form or letter will act as a foundation for the interview
that ought to be conducted privately. Put the applicant at ease by describing your business generally and the job in particular.
Once you have completed this, invite the applicant to talk. Picking the proper person is extremely important. Consult your
questions carefully to find out everything about the applicant that's pertinent to this job.

References are a must, and should be assessed before making a final decision. Check through an individual visit or a phone call
directly to the applicant's immediate former supervisor, whenever at all possible. Confirm that the information given you is
correct. Consider, with judgment, any negative comments you hear and what isn't said.

Checking references may bring to light important Details Which may help save you money and future inconvenience.

Personnel Training. A well-selected employee is only a possible Asset to your organization. Whether or not he or she becomes a
real asset is dependent upon your own training. Remember:

To allow adequate time for instruction. Not to anticipate too much from The trainee in too short a time. To allow the employee
learn by performing under real working conditions, with close oversight. To follow along with your training.

Examine the employee's performance after he or she has been at work For a moment. Re-explain key points and short cuts; bring the
employee current on new developments and invite questions. Training is an ongoing process which becomes excruciating oversight.

Personnel Supervision. Supervision is the next essential of personnel control. Fantastic supervision will lessen the expense of
operating your business by cutting back on the number of employee mistakes. When errors are corrected early, workers will get more
satisfaction out of their jobs and perform much better.

Motivating Employees. Small businesses sometimes face special Problems in motivating employees. In a large business, a good
employee can see An opportunity to progress into management. In a small company, you are the management. One thing you Might Wish
to consider would be to provide good workers a Small share of the proceeds, either via part-ownership or even a profit-sharing
plan. Somebody Who has a"share of this activity" is going to be more Worried about helping to make a success of the business
enterprise.

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