As the key decision maker for your business, it is paramount that your management style is proactive rather than reactive. While you should let your accountant and or bookkeeper prepare your financials the financial management responsibility still falls on you. Business failure may be averted by proper interpretation of your company financial statements and acting before it becomes critical. You need to know how to obtain real value from your statements. The financial statements you should be using to help you be proactive are the Balance Sheet, Income Statement and Cash flow Statement. Business failure is largely due to poor cash management.
Balance Sheet: A report that shows what your company owns and what your company owes at a given point in time.
Income Statement: A report that shows what your company has earned and what expenses it has incurred in a given period of time. It matches effort and accomplishment within a period.
Cash Flow Statement: A report that shows the inflow and outflow of cash. It shows all events on a cash basis as they happen.
It is of course necessary for a business to have enough cash on hand to meet its obligations. Inexperienced entrepreneurs often take a quick look at the cheque book balance, – a practice that can result in misuse of critical cash.
Many business owners find their companies in the position that their business is growing and their income statement shows a good profit; however the phone bill must be paid and there is no money in the bank to pay it. The telephone bill is paid with a credit card at a high interest rate. What is wrong with this picture? It is called a” cash flow problem”. The cash coming into the business is out of sync with the cash going out. You must have a clear understanding of how much and when you cash needs will occur. What sources of cash are available, and when? Small Business owners must understand a few important concepts
Positive net cash flow: cash received exceeds cash paid out during a fixed period of time.
Negative net cash flow: cash paid out is greater than cash received during a fixed period of time.
Accounts Receivable; sales that are put on your customers account rather than paid for in full at the time of sale.
Credit Terms: the time you allow your customer to pay you
Trade discounts: discounts that you offer your customers for shortening the time they take to pay you.
Accounts Payable: the time that your company has to repay the suppliers
Purchase Discounts: a discount offered to your company if you purchase a set volume of goods and services
You must also understand the difference between profits and cash flow. Net income is not Cash. Loan payments do not show up as an expense on your company’s income statement; however they are on the Cash Flow Statement as a cash outflow. Your Net Income figure must be enough to cover loan payments. The Income Statement shows all the sales during a period – whether or not the cash has been collected; and all corresponding expenses – whether or not you have actually paid for the supplies. Your sales figure includes cash tied up in Accounts Receivable. It also includes cost of goods which you may not have paid yet and therefore are part of Accounts Payable. You must understand the timing of your cash inflow and outflow to successfully manage your cash.
In my next blog we will take a look at ways to improve your cash flow and the warning signs of cash flow problems.
Dianne Mueller CPB
Soma Small Business Solutions