Look! Here I am, two weeks later with a new post as promised! As a spin off on my last post, this week I am going to talk about cash flow. Cash flow is one of the single most misunderstood and overlooked areas in accounting, so allow me to enlighten you!
Most are probably familiar with or have heard of a profit and loss statement, and this is the statement on which most business owners focus. Unfortunately, though, the profit and loss statement only tells part of the story. While a business may have a profit on paper, they may be hemorrhaging cash, and this can only happen for a relatively short period of time before a business has to call it quits. Why isn’t this reflected in the profit and loss statement? Well, there are quite a few business expenditures that do not get reflected on the profit and loss statement, and are instead recorded on the balance sheet. These can be things such as investments in inventory or equipment, which could be converted to cash if needed. However, these can also be repayments of debts, loans, or distributions to owners. If major cash outlays are taking place each month for the latter, a business can quickly turn into a sinking ship if there is not adequate cash on hand to cover the expenditures. This generally will result in taking on more debt to cover the operating costs, and further compounding the issue at hand.
As a simple example, say you have $50,000 in revenues in one month, with $30,000 in operating expenses, resulting in a $20,000 profit. If all you are looking at is the profit and loss statement, this is all you know, and you will likely think that things are great. However, if you are taking out $10,000 a month for yourself to cover personal expenses, and $15,000 a month goes to repay debts, that leads to a cash deficit of $5,000 for the month. If this trend continues, it won’t be long until your business is out of cash, and out of options.
How can you prevent the preceding example from taking place in your business? CASH FLOW ANALYSIS! With cash flow analysis, either historical trends or “what if” scenarios can be used to project out what your cash flow will be over the next twelve months, or any specified period. With this, you can see if you are on the right track, or if you need to make some changes to keep your cash flow positive. With a proactive approach like this, you have a much better chance for smooth sailing and keeping your business afloat.
If you’d like to learn more about how cash flow analysis can help your business, please reach out – I’d be happy to help!