Financial Advice Archives - Dart Accounting

Cash flow isn’t a very difficult concept… in theory. But in practice, it can be a little more complicated. In theory, it’s simply a matter of seeing how money moves in and out of your business. In practice, it’s one of the most important elements of your business’ financial health. Getting it right is essential for the wellbeing of any business, but especially small to medium enterprises.

Without adequately understanding and managing cash flow, your business is at risk. In fact, ASIC’s 2018-2019 data shows that 51% of failed businesses believe that the failure was directly due to inadequate cash flow. And that risk is even higher during uncertain times, like those brought on by the impact of COVID-19.

As an SME, your wiggle room may not be as large as a bigger corporation. And when things go wrong, they can go really wrong, really fast. Understanding your cash flow can help you to prepare for and mitigate those risky times so that you can continue to survive and grow despite set backs.

But what is cash flow? What is the best way to calculate it? And how can you manage cash flow so that your business doesn’t fall into ASIC’s 51% failure rate?

What is Cash Flow?

Definition: Cash flow is simply the measurement of the net amount of money coming into and going out of your business over a defined period of time.

Though that’s the simple definition, it’s importance actually lies in its ability to help you understand the financial health of your business by helping you understand your liquidity position (or your access to funds available for you to use). And understanding your liquidity is vital to understanding whether you are in a position to repay your debts, meet your obligations and reinvest in and grow your business. Or whether uncertain times put you at increased risk.

How to Calculate Cash Flow

There are several methods for calculating cash flow. These include the free cash formula, the operating cash flow formula and the cash flow forecast formula.

Basic Cash Flow Formula

The basic cash flow formula is:

Cash flow = Cash from operating activities +(-) Cash from investing activities + Cash from financing activities

This will give you a basic understanding of the money coming in and out of your business.

Free Cash Flow Formula

The basic free cash flow formula is:

Free Cash Flow = Net income + Depreciation/Amortization – Change in Working Capital – Capital Expenditure

The benefit of the free cash flow formula is that you understand what cash you have available or free to use.

Operating Cash Flow Formula

The operating cash flow formula is:

Operating Cash Flow = Operating Income + Depreciation – Taxes + Change in Working Capital

This formula helps you understand the typical cash flow for your business.

Cash Flow Forecast Formula

The cash flow forecast formula is:

Cash Flow Forecast = Beginning Cash + Projected Inflows – Projected Outflows = Ending Cash

This is a simple calculation of the cash you expect to bring in and spend over (typically) the next 30 or 90 days.

Using Cash Flow Statements

The simplest method of calculating your cash flow is simply to use the cash flow statements that are generated as part of your accounting software. Cash flow statements give you an understanding of your current cash position as well as forecast how much cash you can expect to have at any given point.

Managing Cash Flow

Once you understand your current and projected cash flow positions, you are in a good place to begin managing cash flow for your business, including how and when payments are due and made. And once you’re in control of cash flow, you’ll be in a much better financial position within your business and better able to weather any difficulties whether internal or external.

Here’s the steps you can take to help you better manage your cash flow.

Working Capital Requirements

First, you need to understand your working capital requirements – that is the money that you need to keep your business running on a day-to-day basis. In order to accurately calculate this requirement you’ll also need to understand what your assets are (or how much inventory you hold), what money is owed to you and the amount of time it takes to cycle from cash out to your suppliers to cash in from your customers. (This is known as a ‘cash conversion cycle’.)

Establish a Buffer

Once you’ve determined your working capital requirements, you’ll want to work to ensure that you build a buffer above that level. Accountants used to suggest that this be three months to six months’ worth of working capital funds, and while that’s still a good benchmark that set amount has gone by the wayside. Instead, consider how much you would need in the situation where your customers were unable to pay you or you lost income for other reasons.

Remember, you don’t always have to rely solely on business income to create your buffer, particularly in the early days of your business. The buffer can come from business savings, personal funds, overdraft or even a revolving credit facility. Eventually you’ll want to have that money in business funds, but in the beginning that just may not be possible.

Check Your Systems

Review your systems and processes to ensure that you’re invoicing your customers regularly and reviewing incoming invoices to make sure that you are being charged accurately. This will help you keep up to date on how much is owed to you and how much you owe others.

Speed Up Your Conversion Cycle

Speeding up the time between when you spend money (for example, on purchasing inventory from suppliers) and when you collect money (from your customers) will benefit your cash flow position. You could also cut back how much inventory you keep on hand or negotiate longer payment terms with your suppliers to give you more cash on hand at any given point.

Be Easy to Pay

Make it easy for your customers to pay you. Offer multiple payment routes, such as account transfers, credit card payments or even PayPal. And consider incentives to customers who pay on time or better yet, early.

Plan Ahead

When it comes to cash flow, planning ahead will help you to survive when things go wrong. You can do this by preparing cash flow forecasts both for the upcoming year, and on a month-by-month basis. Then make sure that you have buffers in place to cover the tight times.

Talk to Your Accountant

At the end of the day, the best way to manage your cash flow is to have a great working relationship with your accountant who can give you tips and strategies for maximising your cash flow and therefore maximising your success.

For more information on calculating and managing cash flow, get in touch. We’re here to help.

Budgeting for business owners is an essential part of understanding what you need to do to help your business be a success in the new financial year.

July officially marks the start of the new financial year. That makes it the perfect time to start tackling your new year’s financial goals. And to start the financial year off right, you’ll need an updated business budget.

So, we’ve broken down the bare bones of a business budget that will help your business achieve its goals in this new financial year.

Budgeting For Business Owners

Costs

The best way to begin updating your business budget is to start by identifying your fixed costs. These are all the items that will come up each month, at the same price point. They might include rent or salaries, among others, and you’ll likely have real figures for these expenses.

Then you need to figure out your ‘estimated’ fixed costs. These are things like telephones and rates. You’ll have to pay them each month, but the costs will vary somewhat, so you’ll have to estimate the average monthly cost.

You’ll also want to factor in some expenses in the miscellaneous category which will cover costs that pop up unexpectedly. This might be replacing broken equipment or updating software.

Finally, estimate the expense of things that you’re not sure you can afford, but that you would like to. These are the things that you feel would really boost your business to the next stage. If you’re a solopreneur this might be hiring a VA. If you have a team of tradies, it might be updating the fleet, or maybe upping your marketing campaign.

Revenue

After you’ve set your costs, you’ll want to determine your approximate revenue. You do this by predicting your month-to-month sales for the entire year. This can be really hard, and very confronting, especially in the first few years of business.

When your business is very young, it might help to start by talking to other, more seasoned people in your industry, reaching out to potential customers and watching industry trends. This might help you to put together a rough estimate of your potential revenue. But regardless of how you find your number, always include a margin of error in your predictions of between 10 and 20%. Err toward 20% when your business is younger, but the longer that you’ve been in business, the lower your margin has to be.

Monthly Planning

Once you’ve worked out your costs and revenue, you’ll need to start breaking it down month-by-month for the full financial year. This means estimating what impact your expenses will have on your revenue. This involves understanding when you might have increased or decreased expenses (such as when stock might be at a low price, or when demand is higher), or might need to increase ordering for the next month, for example.

Go through each month and determine whether you want to increase or decrease your monthly expenses based on the results of your monthly planning. Keep all this information in a spreadsheet to help you really see your numbers.

Create a Budget Document

Too many business owners stop their analysis at this point. They don’t worry about making an actual budget document once they’ve determined that they’ll be able to keep running their business. But an actual budget document puts the budget in a form that everyone in your organisation will understand.

The simplest form is one that lists projected expenses by category and projected income by source, with totals for each.

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If you’re looking for a budget planner template, start here.

Working With Your Budget

Now that you’ve put in the work to create your business budget, you’ll want to use it. Most organisations review their budgets regularly – once a month is usually a good idea. During your review you can see where your predictions are accurate, and where they weren’t, and revise your budget accordingly. Your budget can also become the basis for other financial documents (such as balance sheets, for example).

Your budget should also help you understand:

If there are any gaps in your funding (and so your ability to keep your business running successfully), where those gaps are and what you need to do to close those gaps.
Help you keep track of your money, so you can adjust to any changes and not overspend (i.e., manage your cash flow).
Help you set goals for your company and see how to accomplish those goals.

Managing Your Cashflow

At the end of the day, the secret to an excellent business budget is using it to help you manage your cashflow. First it can help you ensure you have cash resources to cover any situation that might arise. It can also help you implement changes to your budget when unexpected expenses arise.

Takeaway

Budgeting for business owners in the new financial year is important. It will help you nail down your business’ priorities and keep control of your finances. It will also give you clear guidelines about what you can spend and when, so you know when it’s time to grow your business, or hold back.

If you have any questions about putting together your business budget get in touch. We can help you sort out your costs and expenses for the year, and understand what the number are telling you.

Calculating and Managing Your Cash Flow