Cash Flow Analysis

Understanding 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 in the United States.
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. There also are self-instructional guides from
which you can obtain a better understanding of accounting.

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 befor e 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.

How to Get More Information

Other helpful sources include:
- State Economic Development Agencies
- Chambers of Commerce
- Colleges and Universities
- Public Libraries

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