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Where Is Your Cash Going? Understanding Cash Flow

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Do you wonder where your cash is going?

We know revenue drives the business, the expenses, and ultimately the profit. What if you are seeing your business grow with increasing revenue and profit while seeing little growth in cash?  What could be wrong?

This seems to be a common question,  and it can sometimes be difficult to answer.  Think of Sherlock Holmes solving a mystery. The details give the clues to solve the mystery. What are the details?  What are the clues?

We have to start with putting together actual financials and then forecasting to find the answer. Take a look at the post “It All Starts With Revenue” to understand why this is important.  Since expenses are typically driven by revenue in most cases,  it is important to understand how expenses increase in correlation to revenue.

The mystery is only partially solved when you understand revenue, expenses, and profit. Many business owners focus on the Income Statement or Profit/Loss statement and stop there. Sometimes they don’t even look at expenses such as taxes, interest expense, or depreciation.  If we focus on EBITDA (Earnings before Interest, Tax, Depreciation, and Amortization), it would be like trying to solve a case after one clue in the mystery.  Many details will have been left out.

Understanding Cash Flow

Below are 3 more clues to consider when understanding cash flow. I have noticed these issues are common problems in smaller businesses:

1. Accounts Receivable

Once customers get billed, the invoice is recorded to Accounts Receivable on the Balance Sheet. What if invoices are not properly collected?  Recently with one of my clients, I noticed an increase in Accounts Receivable and slower payments by the customers. As Accounts Receivable increases, then the cash available decreases.  It is important to have a consistent process for following up and collecting on unpaid invoices.  Another of my clients has started to have consistent billing but noticed that collections slowed. Below are some steps to take:

  • Send an email to ensure they received the email or invoice. You are politely just making sure you have the correct contact information or the invoice didn’t get put in the spam folder.
  • Secondly, ask when the invoice is expected to be paid and set a reminder.
  • Larger organizations should have a weekly review of unpaid invoices and assess where they are in the communication.
  • Give the customer a call to ask for payment. At this point, you know they have the invoice, and you are just trying to get an understanding of the delay. Ask if there is anything you can do to help, such as offering to accept payment by credit card or providing additional details to help speed up payment.
  • Eventually, you will have to send a letter saying that services will discontinue if payment is not made by a certain date.

2. Capital Expenditures

All purchases for land, buildings, computer equipment, furniture, improvements to leases, vehicles, and other equipment decrease cash. These items are reported on the Balance Sheet and typically get expensed as depreciation. It can be easy to overlook these cash disbursements if you just look at the EBITDA.

Forecast all capital expenditures to understand if the cash flow can withstand these purchases. A company can be very profitable, but a large capital expenditure can wipe out all the cash profit for the year.

Also be careful not to make large capital expenditures just because it is deductible for taxes. Understanding the future cash flow will ensure you aren’t making a tax decision that will cause business cash flow problems in the coming year.

3. Distributions

LLCs, Partnerships, and S-Corporations will typically use distributions from equity to pay owners for their investment. It is very easy for much of the cash to be fully distributed without realizing it.  A company can be very profitable, but cash distributions take all the cash. This may make a lot of sense for some of you, but it is easy not to see this if you focus on just EBITDA.

One way to solve the cash mystery is to run a report of all distributions in the year. Determine how much are personal expenses (this is common in small companies of one or very few owners).

The mystery of cash can be easily solved with proper entry and review of an Income Statement and Balance Sheet. Of course, if these reports are outdated, then the mystery is lacking the clues needed to fully solve the problem. Not only can you not easily determine where your cash went, but you also will have problems projecting your future cash flow. 

So don’t let this remain a mystery. Once you understand where your cash is going and where it will go, you are well on your way to financial success.

A fractional CFO can help you discover where your business’s cash is going and help manage your business to financial success. Contact us today to gain complete visibility into and command of your financials.