Commandment 3 : “Thou shalt understand how cashflow projection works, as opposed to profit and loss”
Profit does not equate to cash and unless you understand the drivers behind your cashflow you are not going to be able to run your business effectively. These areas can affect your cashflow but not your profit and are mainly found outside the profit and loss statements ie in your Balance Sheet or your Equity account.
- Stock levels – high stock levels mean less cash but not lower profit
- Debtors – high debtors mean less cash but not lower profit
- Asset purchases – paying a lump sum for an asset will affect your bank balance but not your profit
- Creditors – low creditors means less cash but not lower profit
- Incorrect gst status – depending on your business type can affect cashflow eg. A retail business where all sales are received daily should be on an invoice basis. Or a business with high debtors and stock should be on a payments basis.
All of these issues may mean that you are paying tax on profits and you haven’t seen the money yet. This can affect a business significantly. The only way to manage cashflow is to understand it. That means you need to be able to see what is going in and out of your bank account on a regular basis. This can be done on a spreadsheet or a cash summary from your computer system.
Once you know what is happening in your business with cashflow you should have a simple cashflow forecast where you predict the ins and outs on a monthly basis – this will tell you what your bank account should look like at the end of the month.
Opening Bank Balance $
Plus expected income $ All incomes
Less expected outgoings $ All expenses by date
Closing Bank Balance $
You will need to know the historical trends to prepare this and have a handle on your debtor collections, stock movements, creditor payments, automatic payments.
Many of you will have heard someone saying “how can I have made a profit, I have no money in the bank” If someone says this then they do not have a handle on cashflow or the cash drivers in their business.
If anyone would like assistance with a cashflow forecast or setting up cashflow monitoring please give us a call 09 273 3682