In 2016, there seems to be one word on everyone’s mind: revenue. And while revenue is important, a business owner and operator can never forget the number in their bank account. Your business could be the next big thing, but if you do not have the cash to pay your bills and employees, soon it will not matter how much revenue you have.
I have four items you can focus on to give you a better idea of your cash situation. Once you have grown accustomed to looking at these four items, you can then begin to look at a number of different financial ratios, which will help you maintain the correct level of cash.
1. Statement of Cash Flows
So often the first statement business owners and operators look to is their income statement. Rightfully so, the income statement gives an owner and operator insight into whether or not their business is appealing to their market and their expenses are kept in check. However, just because your business had a record month does not necessarily mean your bank account is feeling the same way.
The statement of cash flows begins with your prior period ending cash balance. The statement will then walk through the monthly cash inflows and outflows. While some may think the cash flows statement should mirror your income statement, there is one glaring and simple example that shows the difference: a note payable.
At first, your bank note will be almost entirely allocated to interest expense. All of this interest will hit your income statement, which means you will have an accurate picture of the cash leaving your bank. However, year after year, the amount of interest you pay will decrease, and you will begin to repay more and more of your principal. This principal will never be shown on your income statement. Therefore, by running a cash flow statement, you will be able to see the true amount of cash you are repaying to your bank each and every month.
2. Aging Accounts Receivable
As we mentioned earlier, there is nothing more top of mind than revenue. However, revenue does not always translate into cash. More often than not, you will allow certain businesses and sometimes individuals time to pay for their purchases. While this type of credit program can certainly increase your businesses appeal and revenue, you now must keep track of who owes you money and how long it has been since they paid their balance. The accounts receivable aging summary is a report helps you manage your receivables or people who owe you money for their purchase.
This report is typically broken down by customer and 30-day increments, but you can customize the periods by what your expected collection period tends to be. We typically pull the report each week because we want to ensure we stay on top of those who are outside of their payment period or large receivables that will soon come due.
3. Aging Accounts Payable
The next step is to look at the payables side of your business. One must remember you will often have a certain amount of time before your bills are due. If you have any doubt you are short on cash, we would recommend looking at an accounts payable aging summary to prepare for the upcoming cash outflows.
The next item we review are the cash discounts for prompt payment offered by suppliers. Depending on the supplier, you may be able to receive a discount for prompt payment. While this prompt payment can certainly save a business money, one must also have the cash available. Therefore, it is important to plan for other large payments, which will come due between the prompt payment deadline and the overall payment deadline. You may be forced to disregard the prompt payment in order to meet other obligations.
The final item we are looking at takes us back to our current assets—inventory. Inventory, in its simplest form, is a synonym for cash. As your inventory increases, your cash will decrease. While an owner and operator must have what their customers are looking for, you must also ensure you are selling your inventory fast enough to recoup the spent cash or maintain enough cash reserves to pay obligations which arise. In short, one must find a balance to the on-hand inventory compared to the cash reserves you maintain. While it would be fantastic to maintain an all-encompassing inventory, we simply cannot do so and continue to maintain enough cash to pay bills and payroll.
Regardless of your business, cash is king. By using the four steps above, you will be able to better plan for your business’s future to ensure you are able to meet unexpected obligations as they arise.