Often, when Management for Design asks business leaders if they control their cash flow, we hear a resounding “yes!” But when asked how they do it—the response is usually a more tentative “well… we check the bank account every day.” This is not an effective cash flow management strategy!

Firstly, your bank account is a historical record of the comings and goings of your money. Unless you have a proper plan in place for how you are generating money and how it will be spent, simply reviewing the bank balance daily will not make it grow!

One of the most important tools in business is a cash flow forecast. Would you ever sit in a car, put a blindfold on, and then start driving? That’s what managing a business is like, if you don’t have a cash flow forecast in place.

Three things to set you up for success

1. Know how to differentiate between profit and cash
2. Create a cash flow management system, including a safety bank balance
3. Review and manage your cash flow regularly

Know how to differentiate between profit and cash

Firstly, profit and cash are different. Profit is a measure derived from income (revenue) less expenses and is reported in your income statement. Cash is simply the money you have in your bank account.

Each business transaction will affect your profit and cash in different ways—and at differing times. Paying tax, purchasing computers and equipment, waiting on debtors to make a payment, or the creditors you haven’t paid yet affect your profit and cash position differently. Most of the time, the effect on your cash position can be delayed and occur after the change in your profit position.

So, which one’s more important? Profit or cash? The answer is actually more complicated—and the two are interrelated.

As your business develops, the more you will probably need to invest in systems, equipment, additional people, and premises—all of which require cash. In most cases, you’re investing this cash before you earn any additional profit, so to make more profit or grow your business, you will require more cash. Of course, you can also borrow it or receive it from shareholders or investors, but the point is, to understand how cash and profit impact each other.

In saying this, the age-old saying “cash is king” usually prevails. There have been plenty of profitable businesses that were forced to close down because they ran out of cash. Having a loss on your Profit & Loss statement (P&L) doesn’t mean you’ll go out of business, running out of cash is much harder to recover from.

Looking at just one of these metrics (profit and cash) doesn’t tell you the whole story. Just because you had a profitable month doesn’t mean you had a positive cash flow month. Similarly, just because you have cash in the bank doesn’t mean your business is performing well. That’s why cash flow and a P&L must be looked at together.

Create a Cash Forecasting System

Cash is your single most important asset: It’s the generative capacity of your business. You need a cash system that allows you to forecast, as accurately as possible, your cash in and cash out.

This may start as a monthly forecast, but depending on your needs, it could turn into a weekly or even daily system. The point is, you need some kind of cash forecasting system.

Starting with historical numbers, you can build out your first cash forecast using either a cash management tool or simply Excel. The first time you create your forecast, everything is based on historical numbers and future assumptions. Each month that passes is going to tell you something about the accuracy of those assumptions and give you the opportunity to assess and revise. Ask yourself the following:

• What was inaccurate about your assumptions?
• Was this a “one-time thing”?
• How can you refine your forecast based on the actuals that just happened?

A cash flow forecast, coupled with your P&L, gives you an accurate picture of the financial position of your business and where it is heading. Most importantly, it gives you the knowledge to make more informed strategic decisions.

If you don’t have the capability or capacity to create cash flow forecasts, work with an experienced accountant to create them for you.

Review and Manage

With a cash flow forecast, you can see which months of the year you can expect to face a cash deficit and which months you’ll see surpluses. This information can assist you to hold over funds from surplus months to cover deficit months. It can also give you insights into your business when you compare forecasts to the actual figures.

Not only can a cash flow forecast help you to even out your cash flow, but it can also help you to make important decisions, such as when to make a capital purchase and when to reduce expenses moving forward.

By reducing sporadic cash flow and maintaining a healthy equilibrium, your business can enjoy the benefits of increased stability.

So, what are the steps you can take in your business, to prevent you from running out of cash?

• Ensuring enough cash reserves in your business to cover 2-4 months of expenses (this will depend on your risk profile)
• A cash plan and forecast that you use to make informed business decisions
• A clear understanding of the difference between profit and cash

Management For Design adds certainty to business decisions by combining your strategic goals and hard data. We uncover the fundamentals of your business, identify areas for improvement and enable sound, evidence-based decisions, to move your business and projects forward confidently with fewer surprises. For more information, contact Gordana Milosevska on gmilosevska@m4d.com.au.