Even if you are familiar with accounting, the financial statements produced by your accountant aren’t always particularly useful. They have a standard layout that is prescribed and by the time you receive them, it’s usually three or four months into the new year. Generally, this is because accountants are working towards a deadline such as the tax return deadline and statements are produced for that purpose. As a management tool, this is far too late to be reviewing your financial information.
Note: In this post, the term “cash flow” has been used interchangeably with the terms “cash flow budget” or “cash flow statement” for ease of reading and understanding.
You may have heard the phrase “cash flow is king”, and in a small business, this is very much the case. The cash flow is a powerful diagnostic and planning tool which is often overlooked.
Cash flow is not the same as your profit and loss. If you account on a cash basis (rather than on an accrual basis), it will look similar but the key difference is a cash flow takes into account cash that actually enters and leaves your business. A profit and loss has book entries like depreciation which has no cash impact. A cash flow has entries like tax payments which are technically not expenses so don’t appear in a profit and loss.
The hardest part about a cash flow is setting it up for the first time, but persist because you will come to rely on it and wonder how you managed to run your business without one!
There are two parts to a cash flow – a budget, and actual figures. A cash flow budget is a forecast about your cash movements and should be based both on your past experience and expectations of the future period. Some items will require an educated guess especially if this is the first time you are preparing a cash flow.
Shouldn’t I get my accountant to prepare my cash flow budget?
That’s definitely an option if your accountant works closely with you on your business, otherwise there may be a lot of guesswork involved as the only data your accountant may have is historical information. If your accountant is to prepare your cash flow, consider whether your accountant has information on your future plans e.g. expansion plans, additional marketing, staff, etc. Note that some accountants prefer to concentrate on compliance and regulatory work so if you are thinking of outsourcing your cash flow preparation, you may need to assess the suitability of your accountant.
In my coaching, I usually advise that the task of preparing and monitoring a cash flow remain in a business owner’s hands, as least until there is a clear understanding of how a cash flow is put together and how it is used. It is one of the key tools that helps you understand the financial side of your business. Many businesses fail due to poor financial management which could have been avoided if basics like cash flows were attended to from the beginning.
How do I set up a cash flow budget?
Very much like how you would set up a personal budget. Think about all your sources of income and expenses, then work out when you will actually receive the cash and when cash leaves your hands for payment of expenses. As mentioned earlier, think about items such as tax which is a cash flow item but not a “business expense” as such. A monthly budget is usually sufficient for most businesses. For each month, work out whether you will have excess cash or whether you will be short of cash.
How do I use a cash flow?
Your cash flow budget aids business planning. As a forecasting tool, it helps you work out when your business may be cash-strapped and this can happen even if you are making a profit. If you anticipate a negative cash flow, you can plan for it by ensuring access to funds via other means e.g. a bank overdraft or personal funds, or perhaps adjust your activities such as the timing of large purchases, your stock purchasing schedule, negotiating better credit terms and so on.
As a monitoring tool, you can compare what your actual figures are against what you budgeted. Large discrepancies usually mean questions should be asked. Sometimes, the discrepancy may be cause for concern, sometimes it provides additional information for the following year’s planning. Either way, it’s useful information.
This post was an intended as a quick guide to cash flows for the uninitiated and as such has not covered all possible aspects of cash flows and financial management. If you don’t already have one, get started! Feel free to post any questions or comments that you may have.