Many businesses today are struggling to pay their bills and survive. The few companies that have well-prepared financial statements can see what profits were made for a given period. But unfortunately, most businesses don’t monitor their cash flow — that is, the measure of how much cash a business has to pay its daily bills and keep their business running smoothly.
Measuring cash flow is not difficult as long as you understand the difference between profits and cash flow. Most business owners think in terms of profit. One example of this confusion is a business I worked with two years ago, whose owner told me from across his desk, “I made $200,000 in profits on $1 million in sales last year, yet I can’t pay my payroll this Friday. I don’t understand.”
It took me about 15 seconds to find the problem by looking at his QuickBooks prepared financials. This business was about 2 years old and the owner had done a great job of selling his services. He had done a great job of bidding his projects with solid profits built in. The craftsmanship of his work was impeccable and he had grown the business from about $300,000 in sales the year before to just over $1 million in sales for 2007.
The problem was that his accounts receivable had also grown to $375,000. The company was a subcontractor in construction, an industry that pays notoriously slowly. In addition, general contractors hold a portion of every payment, called retainage. Usually this amount is 10 percent of the amount of a subcontractor’s invoice. The amount of money in retainage could be held for a year or more before the subcontractor collects it, depending on the size of a project. The subcontractor I was talking to just didn’t understand that all of his cash in accounts receivable and almost half of his profits were being held in retainage.
In fact, my customer was never able to understand the difference between cash flow and profits and finally closed his doors. But that never needed to happen.
Monitoring cash flow during a tough economic period like today involves keeping a spreadsheet or using a commercial program that allows you to predict future cash flows in and cash flows out. It is a process that takes a little time to learn and requires attention once or twice per week. But once you learn cash flow forecasting, you will use it forever.
Karen Port of St. Louis-based Mirage Spa and Recreation, Inc. developed her own cash flow forecasting spreadsheet and uses it every week. Her business is 21 years old. She has used her forecasting system during good times and not-so-good times.
Says Karen, “I created it on an Excel spreadsheet and it is divided up into categories so I know quickly what is going on that week. Since I am the management, along with my husband, we have used this tool for over 12 years and it has been useful during both flush and lean times. We would not have survived as long as we have without it. I would highly recommend using a cash flow system to project out what is coming in and what is going out so you know what to do with your cash or lack of cash.”