Friday, May 20, 2016

Community Questions: Understanding Cash Flow

Many business owners struggle when it comes to cash flow management – and rightly so. The concept is a hard one to understand and some accountants even struggle with comprehending the concept – so you’re not alone.

In this blog, I will address several questions submitted to me by the community in regards to their business cash flow.

Why does my net income not match my cash?

In most instances, cash flow will never equal your net income. Even on “cash method” there will always be some delay between the information recorded and what your bank is showing. But if you are on the “accrual method” your net income will never equal your cash.

The recording method for accrual accounting dictates that you recognize your sales and expenses the instant you incur them; not when the cash leaves your bank. Then you have to take into account that some of these customers and vendors will have terms (when their bills are due) – which will always have a direct impact on your cash flow.

Because of this, managing cash flow is a very difficult process if you do not have a proactive approach to your bookkeeping and accounting. Lastly, the longer you wait to input your information, the harder it is to manage the cash.

My company is cash struggling – what can I do to fix the situation before it gets worst?

When it comes to cash shortages, there isn’t a one fix solution; but rather, it is a series of changes coupled with financial discipline. Most cash shortages are a culmination of issues – it is important to identify if your cash shortage is a symptom or a cause.

To do this, you need to evaluate your company’s culture, management style, worker efficiency, and so on to see where the issue is stemming from. Example: Poor management that create a lot of waste will definitely impact your cash flow – but the cash shortage is, in this case, is only a symptom of the overall problem. So it is important to diagnose it correctly.

If, like many small business owners, you draw from your company in order to support your standard of living – then the draw is the cause of your cash shortage. These, sometimes are much harder to fix as it requires financial discipline from the owner.

Often times, I require small to mid-size business owners to have both a personal and business budgets. These budgets help in ensuring the owners and the business stay in sync with one another – setting a definitive spending point for both. But the hardest part is not using the company credit card for coffee, snacks, sodas, and so on. It’s the small charges that adds up quick.

What is “Organic Cash Flow” and why is it different from normal cash flow?

Organic Cash Flow is a relatively new word. In essence, it is your normal cash flow. But when it comes to managerial purposes, organic cash flow refers to the cash flow that the company currently generates without any additional changes.

When it comes to increasing organic cash flow, you are not looking at increasing working capital as stated above. Instead, you are looking at ways to free up the cash flow so it can be put to better use.
Things that impact organic cash flow are usually liability related – loan payments being the biggest one in America. If you generate $1,000 and pay $600 to a loan; your cash flow is $1,000, but your organic cash flow is only $400.

Generally, accountants will assess a company’s cash flow then determine its organic cash flow. Decisions are then based off of that organic cash flow – can a new piece of equipment be added? Should the loans be refinanced to free up the cash? Can other companies provide a better quote? And so on.

In short, Normal Cash Flow is often your total cash flow (how much your company brings in during a week/month/quarter/year). Organic Cash Flow is the cash left over after paying vendors, lenders, and such – and is it enough to accomplish future growth or will the company plateau out because it doesn’t generate enough cash? These are questions you need to ask yourself.