What is cash flow?
Hi, my name’s Dustin Slightham, and today we’re going to be talking about the importance of cash flow within your business. But first, to give you a little background on myself, I’m a local Lynchburg entrepreneur, I started my business about 5 years ago. Cash flow is actually a really interesting topic for me. I sort of have a kinship with it – I was a finance grad, and one of my earliest mentors in the finance program used to talk about how cash is king. It’s interesting from the corporate experience that I had – I worked with a Fortune 500 group – cash wasn’t as important to me at a lower level of the organization, but when I stepped out on my own, cash became incredibly important. So today we’re going to cover why it’s important. We’re going to cover a little bit about the statement of cash flows and what it’s made up of, and we’re going to talk about the cash budget, which is actually used for the financial management of your day-to-day operations.
What is cash flow? A very simple definition, it’s taking a look at the cash in-flows versus the cash flows of your organization. It’s really showing the livelihood of it, and how you’re spending money, how the business is actually operating from a cash perspective. When we look at a statement of cash flows here in a second, you’ll see that it’s broken into three primary areas: operating activities, investing activities, and financing activities. Really what the cash flow does for us as we look at the statement of it, and we look at overall flow within the business, it answers questions like: How’s the business spending its money? Can it service its debt? What is really causing changes within the cash position of the organization?
Why is cash flow important? As my professor used to say, cash is king. Honestly looking back over the last four years, I couldn’t agree more with him. It truly is the lifeblood of your organization. Keeping a close hand on your free cash balance and your statement of cash flows is really important because it helps you understand whether or not you can service the debt obligations and the operating obligations that you have within your organizations. A lot of times, if you’re looking at only an income statement or perhaps a forecast that might be too optimistic, you might look great on paper, but if you’re not paying attention to your cash balance, you could crush your organization. Another way that really the statement of cash flow can become helpful is around making investments or growing your organization. For example, if we opened a bakery shop, if they had a really small oven but the demand for their cakes was starting to increase, that would be exciting, but let’s say we weren’t really paying attention to our cash position. We might have a moderate to slight increase in our cash receipts, but we’ve had to increase payroll in the organization which is now starting to reduce the amount of cash that we have at the end of that period of time. Well if we’re going to try to grow the organization, maybe there’s a piece of equipment that we could buy like a bigger oven that could produce a quadrupled amount of supply that you could create or capacity that you could create. Maybe you could even reduce your payroll expense with it. Keeping an eye on your cash balance will help you determine whether or not you can make that investment, and of course you’ll want to look at the cost-benefit analysis of making the investment as well. So that’s another way that cash really helps you look at things. It also helps you from … am I going to hit a pitfall? Am I going to hit a period of time … So for 434 Marketing, we’re a service-based organization. Let’s say one of our larger clients decides to discontinue service with us. How are we going to serve the obligations that we have from a payroll perspective – our single largest expense? So keeping an eye on things, making sure you have a strong cash reserve, and an outlook over a certain period of months is super helpful, making cash flow really important for your organization.
So what is a statement of cash flow? When we look at one, it’s looking at a specific period of time and how the cash has actually translated from that one point to the end point. When I say a specific period of time, I mean maybe a year, maybe a month, maybe a week, depending on when you pull the report and how you pull the report. As I mentioned earlier, there are three main areas to a statement of cash flow: your operating activities, your investing activities, and your financing activities. The operation activities primarily consist of your net income. It’s all the transactions that determine your net income. The investing activities are all of the transactions that are affecting any of your long-term assets. So if we use the baker example, essentially it would be the oven the baker purchased to put in the bakery. And financing activities are transactions that impact long-term liabilities and equity. So for example, if you were to take on a line of debt because you’re in a negative cash position, and you needed that debt to keep the business moving forward and keep up with all of your obligations, that would show up there.
The statement of cash flow isn’t as excellent as I’ve said all along through this tutorial document to constantly have and constantly review. But on a day-to-day basis, the document I find i more helpful is a cash budget. This is used more for financial management as opposed to accounting. So on the next slide, we’re going to talk a bit about what that cash budget looks like and how we use it here at 434 to manage our cash balance.
Looking at your cash budget and how to prepare it, one really important distinction between a statement of cash flows and a cash budget is a statement of cash flows really looks at what has happened. It’s going to give you an idea of the flow of money over time in history. Whereas a cash budget is going to help us predict the future, or determine how things are going to go moving forward. One of the most important things when preparing a cash budget is your ability to assess your receipts. You don’t want to take a forecast that’s got these inflated numbers of optimism and include that into your budget. The single reason you don’t want to do that is it may lead you astray and you might start making investments or increase payroll expenses or buy new inventory or things along those lines when you don’t really have the ability to do so. Maybe you have a really strong month, you’ve got a great cash receipt that comes in, but the next month you’re predicting to get something similar and you don’t, you really need that money to weather that storm or that loss you might incur in that next month. You really want to get a good handle on your cash receipts and make sure that they are strong and you’ve got a good understanding of them.
I’ve included here a quick example of what a cash budget contains. First, it’s got your cash balance, which is similar to your beginning cash balance, which is similar to your cash flow. Then you’ve got your revenue or receipts you anticipate bringing in for that specific period of time. That will give you your total cash available. Then you’ll move into disbursements payroll, costs of goods sold, anything around operating activities you’d report on your statement of cash flows. That’s going to give you an idea of your total disbursements made during that period of time and the excess or deficient number. If you’re deficient, you’re going to have to figure out how to manage that deficiency. If you’re just starting out, you’re not going to pay yourself, or maybe you’re going to take on a loan. After that, you’re going to have your ending cash balance, and that ending cash balance will apply to the next subsequent period of time. It’s going to become the beginning cash balance for that period of time.
Really, at 434 to give you an idea, we update a document that is set off of the same set of principles that is a cash budget. We update that every single day. For the periods of time that we tie it to, we actually tie it to our largest expenses which is payroll as a service organization. So every payroll period we are looking at our cash budget and we’re making decisions based off of that. What’ I’ve found that has been really helpful is that it points out an deficiencies that we might have coming from cash in the future. So when I look at how I’m going to predict my receipts, again that’s why it’s so important to make sure those numbers are as accurate as possible, because if a deficit is coming up, we need to start looking at ways we can either shape some costs or bring in some capital that can help us weather that storm.
As part of this, I wanted to give some practical next steps – some things you can put in place. I’ve come up with 3 next steps.
The first is creating a method for assessing your cash receipts. I’d caution you here: do not be too optimistic. The rule we have is if it’s not under contract it’s not included in our cash budget. We’ve come up with ways to include forecasts in there so we can paint a little bit of a picture, and included in that forecast we add associated expenses with is so we can get a better picture of things. But in this case, in this document that I’m going to share as part of this tutorial, I’d recommend coming up with a really good way to harness your incoming revenue and make sure you’re actually going to receive those receipts to the best of your ability, of course things happen, but I wouldn’t put in things like “we project that our revenue based on last year is going to increase by 50% because we had a really good month.” I’d be looking at things like what contracts we have in place, what things are more predictable, what have we seen from a run rate standpoint. For example, if you don’t have recurring revenue, what trend did you see last month and the previous month, and from there, maybe give a small uptick or keep it completely flat lined. Some people may recommend other things, but I tend to be very real about the cash budget because I don’t want to run into an issue where I can’t finance my opportunities and my obligations. What I’d rather be able to do is get surprised when we get an excess amount and we actually beat that budget.
The second component is I would set up a cash budget – statements of cash flows is going to look at the history of how you’ve done. A budget is going to help you prepare for the future. I’d set something up that is very easy to maintain – something you can go into each and every day and adjust and monitor and look at. If you’ve got an admin who would be great, it’d be good to have them send out a weekly email that has your current cash balance and big upcoming expenses for that next period of time. That way you’ve got a top of mind and a good handle of things and you can address issues as soon as you’re made aware of them.
Lastly, review and adjust all the time. Be in that document. Don’t just build it and let it sit. Constantly be updating it. Constantly be keeping an eye on it, and it’ll really help you build a business toward success.
Thank you for your time. I hope this tutorial was helpful for you, and I look forward to seeing you around Lynchburg.
About Dustin Slightham
Dustin is a tech geek and entrepreneur at heart who loves to gauge the success of creative ideas with data. He is the president and cofounder of 434 Marketing. After graduating with a degree in Business Finance from Liberty University, Dustin started working for a Fortune 500 company as an Operations Leader. Over the course of the next four years, Dustin would manage a 200-person team, a $20M budget, and work alongside Product Managers to create a $1.5M custom software solution. In addition, he would gain $1M worth of new business by developing a new process for a large-scale backfile project. Hard work and determination, coupled with consecutive 80-hour work weeks, culminated in him leading his team to receive the prestigious Supplier of the Year Award from his client, Genworth Financial.
After being shaped by the corporate world with skill sets like Six Sigma, software development, team leadership, sales, P&L management, and consistent executive level exposure, Dustin felt prepared to venture out as an entrepreneur in 2011. At the time, Dustin saw a need for business owners that wasn’t being met: creative marketing that uses cutting-edge technology and is traced back to tangible metrics. This is how the Carrot Saver application and Carrot Creates website design agency were founded.
|Date Added||June 30, 2016|
In this video, Dustin overviews cash flow and what it means for your growing business. He covers:
- What is Cash Flow?
- Why is Cash Flow important?
- What is a statement of Cash Flow?
- What is a Cash Budget?
- Where do you go from here?