As a business owner, it’s imperative that you’re aware of your cash going in and out at all times. As they say, “cash is king” in any business. When you have money in the bank, you can purchase the supplies needed for your next product launch, deal with unexpected expenses that arise, and ensure you are getting paid for all your hard work.

It’s also important because the cash the company has on hand must be able to cover the firm’s tax liabilities. Oftentimes, small business owners ask, “How can I owe any taxes… I don’t have any cash in the bank?” This stems from a misunderstanding of how cash flow works.

Recently, Lagerquist Accounting & Advisory hosted an interactive educational workshop on this very topic, entitled, “Where’s the Cash? Finding, Understanding, & Managing Cash Flow in Your Small Business.” Participants included leaders in the fields of finance, healthcare IT, legal, and other small business sectors.

Sylvia Lagerquist, founder and president of Lagerquist Accounting & Advisory, designed this session to explore the key differences between the concepts of cash flow and profit and loss, giving participants more proactive tools to set up their businesses for financial success.

We’d like to share four important questions that were discussed and answered during the workshop:

1. What are the differences between your profit & loss and your cash flow?

Cash Flow

Sylvia describes cash flow as the incomings and outgoings of cash, representing the operating activities of an organization.

•  Your cash in could be from sales and revenue, money borrowed, or cash you’re investing in your business.
• Your cash out might be money you use to pay back a bank loan, to buy inventory, or money taken out of the business for yourself. Sylvia points out that the cash going out might not necessarily be an expense of the business.

Profit & Loss (P&L)

Profit & Loss (P&L) is described as a company’s revenue and expenses over a particular period of time, typically either one month or consolidated months over a year. Sylvia explains P&L is your revenue minus your operating expenses. Your P&L reflects income and expenses, but not necessarily cash in and cash out.

Since this is a confusing concept to some, Sylvia encouraged participants to do some number-crunching during the session. They were given a fictional situation relevant to their businesses, and asked to figure out cash flow vs. P&L.

For example: Let’s say you have $10,000 in revenues, $5,000 in operating expenses, a $7,000 bank loan (and you’ve paid back $2,000 of it).

•  To calculate cash flow, we’d take the $10,000 in revenue, subtract the $5,000 in operating expenses, add the $7,000 loan, and subtract the $2,000 loan repayment, for a cash balance of $10,000.
• To calculate P&L, we’d take the $10,000 in revenue and subtract the $5,000 in operating expenses, for a total of $5,000. (Keep in mind that the $7,000 bank loan is not considered income, nor is the loan repayment of $2,000 considered an expense, thus not included in the P&L).

The key learning here is there’s a big difference between expenses vs cash flow!

2. How do you calculate how long your cash will last when there are no business operations?

In the not-too-distant past, businesses were suddenly faced with this exact dilemma. It’s crucial for business owners to know how to calculate the extent of their cash flow so they can plan for worst-case scenarios. Using a monthly profit & loss statement, Sylvia guided participants through a five-step process to calculate how long their cash would last if their business operations came to a halt.

• Calculate your monthly fixed costs. These are the expenses you will have to continue to pay even if there is no revenue. This is applicable for businesses who are closed down, but also for those just starting up. Some fixed costs are rent, utilities, insurance, property taxes, owner compensation.
• Identify your other monthly cash requirements. In the example above, the $5,000 loan payment would be in this category.
• Determine your total monthly cash requirements. Add your fixed costs and other cash requirements.
• Identify the cash you have on hand.
•  Calculate how long your cash will last. To do this, divide your cash on hand by your total monthly cash requirements.

3. How do you calculate how long your cash will last when business operations are reduced?

As we recover from a global pandemic, many businesses find themselves with some revenue coming in the door, but maybe not enough to make ends meet. During challenging times like these, business owners would benefit from calculating how long they can stay afloat with limited revenue. Sylvia helped participants navigate this dilemma so they would be prepared in cases of reduced earnings.

•  As in the above example, first identify monthly your fixed costs, other cash requirements, and total your fixed and other cash requirements.
•  Identify your variable costs. This involves adding your costs of goods sold, your payroll, and your office supplies.
•  Determine your gross profit by subtracting your variable costs from your revenues.
•  Calculate your gross profit percentage by taking your gross profit and dividing it by your revenues. (For example, if your gross profit is $29,000 and your revenues are $100,000, your gross profit percentage would be 29%).

Sylvia encouraged participants to determine how long they could operate if their business operations were reduced to 50%. In the above example, there were $100,000 in monthly revenues, so in this situation your reduced revenues would be $50,000.

• Calculate your gross profit by multiplying your revenues by your gross profit percentage (29%). In this situation, your gross profit is $14,500.
• Subtract your monthly cash requirements from gross profit. For example, if your gross profit is $14,500 and your monthly cash requirement is $33,000, you would have a negative monthly cash flow of $18,500.
• Determine your cash on hand.
• Divide your cash on hand by your total monthly cash requirements. For example, if you have $100,000 cash on hand and your total cash requirements are $18,500, your cash would last you 5.4 months.

4. What are some helpful ideas to make your cash last?

We’ve learned throughout the pandemic that we need to be resilient and creative as business owners. Workshop participants were advised to prioritize increasing revenue versus trying to cut fixed expenses. “You can’t cut your way out of a problem. Certain fixed costs cannot be reduced, regardless of whether or not a business is operating,” asserted Sylvia Lagerquist.

These strategies were extremely helpful for many entrepreneurs during the early stages of COVID, and many are also relevant for new businesses today.

•  Look for sources of cash:
  ○ Explore opportunities for grants and loans.
  ○ Examine your accounts receivable, and reach out to those who owe you money.
  ○ Investigate other sources of revenue, such as tax refunds, tax credits, etc.
  ○ Research other lines of revenue.
  ○ Consider price increases, relevant to the market.
•  Explore ways to reduce your cash outflow:
  ○ Research debt relief and deferment programs.
  ○ Defer tax payments.
  ○ Reduce expenses.
  ○ Consider lowering payments and interest on credit cards, payments to vendors, and owner compensation.

Summary

As business owners, it is important for you to regularly examine your budget and be proactive with your business finances. One of the most immediate areas in which an outsourced CFO can have a positive impact on your small business is in cash flow improvement. From working capital to cash flow projections and beyond, cash flow strategy can dramatically improve your operations and finances by addressing weaknesses in cash management, inventory control, billing, collections, receivables management, and more. To learn more about how Lagerquist Accounting & Advisory can serve your business needs, please contact us via our website or by phone at (301) 927-0020.

Image Credits: ktasimarr (Canva @ Creative Commons)