Cash Position

Part of being the CFO of your small business is to be able to make sense of the numbers.  Only once you can turn your data into usable information can you more effectively plan out your business.  Understanding your cash position is important because your business must be able to generate cash to survive.

If you have been around long enough, then you have heard the saying “Cash is king.” But what exactly does this mean?  In simple terms, cash is like oxygen and a company must be able to generate cash in order to survive.  When the cash runs out the business becomes unable to function. Similarly, a company which focuses only on revenues or profit is only focusing on half of the picture because the company can still fail if it is unable to convert profit into cash.  Effectively managing your company means that a cash position must be forward looking.  This is achieved by forecasting so that you can effectively make your cash work and to be able to prepare ahead of time for any potential financial shortfalls.

Here are some things to keep an eye on that will help you to monitor your cash position.

  • Liquidity: Many small business owners start off by focusing on revenue, profit, and expenses when the begin to keep track of their financials; however, this does not paint a complete picture of the cash position. Non-cash expenses, such as depreciation and expense payments such as those towards balance sheet items such as fixed assets, loan principal payments and inventory purchases can also reduce your cash position.  Proper forecasting of your small business’ cash position should take all items into consideration.  The best way to get a true picture of your cash position is to combine three financial reports of a Profit and Loss, Balance Sheet, and Statement of Cash Flow.  This can allow you to get a clear picture of your business’ historical, present, and future cash positions.
  • Credit: One way for a small business owner to ensure that the business can manage a strong cash position even when things get tough is to have access to various types of credit. In a crunch, the increase in the use of credit will result in an increase of available cash.  On the other hand, decreasing your used credit, or paying down debt. Reduces the cash that would be available for other uses.  Because the terms of your credit accounts cannot be determined by looking at the Profit and Loss statement, it is important that you fully understand the payment terms of your business’ debt so that the debt servicing remains timely.
  • Accounts receivable (A/R): All businesses take money in. If your business does not, then it will be out of business before long.  At some point, almost every business will find itself being owed money from someone.  Generally Accepted Accounting Principles (GAAP) requires the accrual method of accounting, which means that the Profit and Loss statement records sales in the month they occur, not when the cash is received, there are other reports that should be utilized to help paint an adequate picture of your cash position.  Here some reports and how they can be used:
    • Open Invoices – Lists unpaid invoices and statement charges, grouped and subtotaled by customer.
    • Customer Balance Summary – Shows each customer’s total open balances.
    • A/R Aging Summary – Shows unpaid invoices for the current period and for the last 30, 60 and 90+ days so you can see how long they’ve been open (outstanding).
    • Customer Balance Detail – Lists unpaid invoices for each customer, including invoice date and number, due date, total, and amount owed to you (open balance).
    • A/R Aging Detail – Lists all unpaid invoices, grouped by number of days past due. Includes due dates, customer names, amounts, and totals for each billing period. Aging reports should be generated so that reliable estimates of when cash from sales will be received.
    • Collections Report – Shows overdue invoices grouped by customer. Includes the due date, days past due, and total for each customer.
    • Invoice List – Shows a chronological list of all your invoices for a selected date range.
    • Statement List – Lists statements you sent to customers during a selected time period, including the statement date.

These reports need to be monitored regularly to ensure that customers are paying on time.  All collection problems should be addressed properly and promptly.

  • Accounts Payable (A/P): The accrual method (required by GAAP) requires that expenses are recorded at the time in which they occur, not when payment is made. This creates the current liability referred to as accounts payable.  Accounts payable are essentially a type of short term debt that originate when items are purchased.  As a small business owner, it is important to understand the payment terms for each of your vendors.  This will help you to ensure that you do not run into a surprise by having an unexpected bill become due and you have a shortage of cash. The effective use of reports can help paint a picture of your cash position and help you prepare for paying your bills.  Here some reports and how they can be used:
    • A/P Aging Summary – Shows unpaid bills for the current period and for the last 30, 60 and 90+ days so you can see how long they’ve been open (outstanding).
    • Vendor Balance Detail – Lists all the bills that make up the total amount you owe each vendor (balance).
    • Bill Payment List – Shows all the bills you paid during a selected date range.
    • A/P Aging Detail – Lists all your unpaid bills, grouped by when the bill was due (aging period). Includes due dates and amounts.
    • Unpaid Bills – Shows your unpaid bills, their due dates, and days past due so you can avoid late payments.
    • Vendor Balance Summary – Shows the total amount you owe each vendor.
  • Projections: In simple terms, a financial projection is a forecast of your future income and expenses. The ability to have ongoing cash flow projections is ultimately where all small business owners need to arrive.  Once you are in a position where you are properly managing your Profit and Loss statement, Balance Sheet, and Statement of Cash Flows, then you will have the foundation in place to allow you to employ cash position projections.   This type of analysis will help you get a better handle on your future cash position, enabling you to plan more effectively.
    • Profit and Loss Statement – This shows your business’ income and expenses over a specific period of time and should be presented on the accrual basis. Some of the key components of this are:
      • Income
      • Expenses
      • Total income
      • Income taxes
      • Net income
    • Statement of Cash Flows – This statement identifies all of the items affecting your cash. It isn’t your operating profit or loss..
      • Net Profit or Loss from operations.
      • Increases or decreases in Accounts Receivable – If your accounts receivable (sales) increase in a month your cash will decrease
      • Increases or decreases in Accounts Payable – If your accounts payable (expenses) increase in a month your cash will increase
      • Increases or decreases in Assets – If your assets increase your cash decreases
      • Increases or decreases in Liabilities – If your liabilities increase your cash increases
      • Non-cash expenses depreciation and amortization will increase your cash from operations.
    • Balance Sheet – This shows the net worth of your business.
      • Assets
      • Liability
      • Equity

By understanding your sources and uses of cash you will be able to understand and project your future cash position, which is essential to ensure that your small business does not get overextended.