Improving cash flow is a smart move for any business.
It doesn’t matter how great your business model is, how profitable you are, or how many investors you have lined up. You won’t survive if you can’t manage your company’s cash.
In fact, one study found that 82% of businesses fail due to poor cash flow management skills. If you’re looking for one area to focus on that will have a dramatic impact on your business, this is it.
Established businesses often have a buffer of extra cash to get them through shortfalls. Growing businesses often don’t because they are always reinvesting.
Years with the biggest growth—including the first few years—are also the most challenging when it comes to cash flow. This is one of the reasons it’s so hard to get a new business off the ground.
Getting good at managing cash flow is one of the best things you can do for your business. Not only that, it’s a skill you can carry over into other businesses, as well as your personal finances.
Note: We’ve put together a free template to help you manage your cash flow. Find it at the end of this blog post and keep reading to learn how to use it.
The Difference Between Cash Flow and Profitability
Cash flow is not the same as profitability. A profitable business can still be unable to pay its bills. Similarly, just because a business is meeting all of its financial obligations, doesn’t mean it’s profitable.
Profit is an accounting term, which really only exists on paper. Measuring profit is a very specific way of looking at a business. It doesn’t tell you a whole lot about how the business is getting by day-to-day.
Profit is typically calculated in two steps. The first is to take your total revenue and subtract the cost of the goods sold. The difference is your gross profit.
Revenue — Cost of Goods Sold = Gross Profit
For example, if you sold $100,000 in rocking chairs, and the chairs themselves cost you $50,000 wholesale, your gross profit would be $50,000.
Cost of Goods Sold -$50,000
Gross Profit: $50,000
Of course, you would probably have other expenses beyond buying the chairs. For example, you’d need a place to store the chairs, and you might want to run some ads to get more sales. These expenses are called operating expenses and they get subtracted from your gross profit.
Operating expenses include most costs that are not directly connected to what you’re selling. Things like rent, equipment, payroll, and marketing.
The second step of calculating profit it to subtract operating expenses from gross profit. The difference is net profit.
Cost of Goods Sold: -$50,000
Gross Profit: $50,000
Operating Expenses: -$35,000
Net Profit: $15,000
If your net profit is a positive number, you made money. If it’s a negative number, you lost money. This report as a whole is called the income statement or profit and loss (P&L).
The Problem With Profit
The problem with income statements is that they don’t show your whole business. A few very important pieces of information are missing.
1. Debt Repayment
If you have any business loans or other startup capital to repay, it won’t show up here. Only the interest on those loans will be included on a P&L. Even though debt repayments can eat up a lot of cash.
2. Equipment Payments
Similarly, if you make a major equipment purchase, the entire cost will not show up here. Instead, that cost will get spread out over the lifetime of the equipment. If you spend $100,000 on a canning line and you think it will last you ten years, your income statement will show an expense of $10,000/year for ten years. Even if you had to pay all of it upfront.
It’s also important to note that your net profit hasn’t been taxed yet. This means it’s going to shrink even more. Even if all of your profit is available in cash, you won’t be able to run out and spend it all in one place.
4. Cash Received
Finally, many businesses use accrual accounting, which records revenue even if you haven’t received the money yet. On paper, you might have $200,000 in sales but if nobody has paid you yet, you’re still going to have a hard time paying the bills.
Further, if you carry inventory, all that product has value and gets included on your income statement as well. Of course, in order to extract cash from your inventory, you need to sell it first.
You can start to imagine why profit has little bearing on cash flow.
It’s All About Timing
Ultimately, cash flow comes down to timing. You may be profitable over the course of a month or year, but not a specific day or week. If your bills are due at the beginning of the month but you won’t have any money in the bank until the end of the month, you’ve got a cash flow problem. Even if at the end of the month, you made more than you spent.
Here’s the deal with profit. If you’re not profitable on paper, you’re in bad shape. You need to either increase your revenue or decrease your expenses if you want to stay in business.
But just because you’re profitable, doesn’t mean your business can run on autopilot. You still need to watch your cash—especially if you’re growing.
Benefits of Cash Flow Management
Although it may seem intimidating, there are clear benefits to prioritizing effective cash flow management.
1. Predict Shortfalls
The first and most obvious benefit to managing cash is knowing ahead of time when you’re going to have shortfalls. Don’t find out you can’t make rent after the check bounces. With a good system in place, you can predict shortfalls weeks, and sometimes even months ahead of time. This will give you time to come up with a plan. For example:
- Call your landlord and ask them to cash your check a couple days later
- Delay a shipment by a couple weeks to put off paying duty at customs
- Run a promotion too quickly drive additional sales
- Go on a collection to spree to clear up outstanding bills
2. Reduce Stress
Believe it or not, obsessing over cash flow will alleviate a lot of stress. Much of the anxiety entrepreneurs experience around paying bills comes from not knowing what’s going on, and worrying about whether or not it will work out.
It’s much better to know what’s coming, even if the outlook is not good. When you actually know where you stand, you’ll feel prepared. More importantly, you’ll be equipped to deal with it.
3. Know When to Grow
When you’re keeping an eye on cash flow, you know exactly how much money you have to spend on growth. Remember, just because your P&L tells you there’s extra money lying around, doesn’t mean it will materialize in real life.
Similarly, just because you have $20,000 in the bank, doesn’t mean you can spend it. You might need it to pay for upcoming expenses. When you look at your cash flow over the course of weeks and months, you’ll know how much have on hand to squirrel away or spend on growth.
4. Gain Leverage
Good cash flow management gives you leverage. If you need a line of credit from the bank to get you through a shortfall, or you want to get a supplier to give you a break for a couple weeks without interrupting service, a good cash flow system will back you up and establish trust.
Banks generally like to see this kind of planning, especially if you can clearly show when you’ll be able to repay the funds. Suppliers are much more likely to be flexible if you can tell them exactly how you’ll pay and when, rather than dropping off the face of the earth like most businesses do during tough periods. These people want your business and will be more willing to work with you through the ups and downs if they can trust you.
5. More Accurate
Cash flow is significantly more accurate than a budget. Budgets tell you what you want to happen. They’re wishful thinking and entrepreneurs are optimistic by nature. Cash flow projections tell you what is actually happening so you can deal with it—even if it’s not what you planned at the beginning of the year.
Most of us (myself included) would often rather not think about cash flow and just hope it works out. But it’s not worth the risk. You really will feel better staying on top of it.
How to Forecast and Manage Cash Flow
There are a number of paid tools out there to help you manage cash flow. Personally, I think the free one is the best one: Google Sheets. Anyone can use a Google spreadsheet to organize their cash. Although, it’s a manual process, it doesn’t take long to set up, and it’s easy to stay on top of.
More importantly, it’s easy to customize on the fly and adapt to your specific needs or situation. You can be as broad or specific as you want. And the time you spend creating and updating your spreadsheet is valuable for gaining a clearer picture of your situation.
The cash flow spreadsheet is basically an outline of where your cash is going. It shows you when cash will be coming in, and when it be going out. It’s a great way to quickly visualize and adjust.
Most businesses work best by planning week-to-week. However, some may need daily, others only need monthly. It’s also up to you if you want to include every single expense or just categories of expenses. These decisions will depend on the scale and complexity of your business.
Similarly, some businesses will be able to project their cash flow accurately for six months, others only two weeks. In general, try to project four to six weeks reasonably accurately. A good rule of thumb is that the farther you are into the future, the less accurate your predictions will be.
Step 1 – Forecast Expenses
The first step is to lay out all your ongoing financial obligations. Start by making a list of all the things you have to pay, from rent, to salary, to advertisements, to software fees, to loan repayments. Anything that comes out of your bottom line. Write down what the expense is for, how much it is, and when it’s due. You’ll likely forget about a few things so go through your bank and credit card statements to see what else you come up with.
Step 2 – Forecast Revenue
Next, it’s time to forecast your weekly revenue. Many businesses experience fluctuations in sales so it can be a bit of an art. Try to be as accurate as possible. The more established your business becomes, the easier it will be.
Start by writing down any guaranteed revenue. If you sell subscriptions or have long-term contracts, you’ll have a good idea of what’s coming up. You can estimate if those numbers are going to go up, down, or stay the same.
If a large portion of your sales are from first-time customers, it will be more difficult to estimate. Still, you should have a good idea of what to expect over the coming weeks and months. The closer you can get to reality the better.
One thing that can really help with projections is to look at past data. In many cases, your sales from this week a year ago will be more accurate than your sales last week. This is because historical data takes annual cycles and seasonality into account. If you believe your sales will grow over last year’s, you can increase the amount, but it’s important to be conservative so you don’t end up in a sticky situation.
As you forecast revenue each week, be mindful any dips in sales due to holidays, the time of month or year, as well as any promotions or major deals that will impact your revenue.
Step 3 – Plug in Your Data
Now comes the fun part. It’s time to fill in your data. First, grab your free copy of the cash flow projection template. Use it customize a row for each expense and each revenue source. You can be as detailed or broad you need to be.
If you sell a bunch of products on one website, you may only have one source of revenue. If you use multiple channels such as web, retail, and trade shows, you might want to have a line for each because it will be easier to predict.
Make sure you add revenue to the week it will become available to you. Keep in mind, it may take a few days to end up in your bank account.
Similarly, fill in your expenses. Some will be weekly, some bi-weekly, some monthly, some variable. You’re also going to have a lot of miscellaneous expenses popping up. Use the row labeled “Other” to work these into the spreadsheet.
Add your opening bank balance for the first week. The following weeks will be predicted automatically based on your revenue and expense projections.
Step 4 – Update Your Spreadsheet
Your cash flow spreadsheet is a living document. If you keep it as a Google Sheet, it will be available anytime, anywhere. You’ll also be able to easily share it with someone else such as your accountant or another employee.
A good cash flow spreadsheet is updated on a regular basis. Once a week, log in and update your closing bank balance. If it doesn’t match up to what was previously calculated, it’s a good idea to figure out why. Sometimes expenses you forgot about pop up, or you realize you may have been too optimistic in your revenue projections.
Next, hide last week’s column. You won’t need it anymore since it’s in the past.
Finally, add a new week of projections in the last column. You always want to have a minimum of four to six weeks laid out so you can plan ahead.
Any time you’re projecting a shortfall, the closing bank balance will alert you by turning red. This will give you an opportunity to make some changes. In the template provided, you can see that a shortfall is predicted in the third week.
By knowing this ahead of time, this company could contact their product supplier and renegotiate their next payment. Instead of paying all $5,000 that week, they could ask to pay $3,000, and settle the remaining $2,000 the following week.
Free Business Cash Flow Projection Template
If you haven’t already, don’t forget to grab your free cash flow template. Simply click on the this link and you’ll be taken to the document in Google Drive. Click on “File” → “Make a copy…” to save your own editable version of the spreadsheet. You need to be logged into your Google account to make a copy.
Most companies simply can’t survive without good cash flow management. But anyone can do it. Take the time to get organized now and it’ll be easy to stay on top of it.
How do you track your cash? I’d love to hear about it in the comments!