Avoid That ‘Dangling Over an Abyss’ Feeling

A small business operator who doesn’t understand cash flow is figuratively dangling from a rotten tree branch over a financial abyss. Adequate cash relieves pressure for meeting current obligations and implementing future expansion.

You don’t need a wide-ranging survey of the financial environment to “get” cash flow; paying attention to a few factors is all that’s required to be the architect of your cash flow success.

Cash flow analysis

A cash flow statement is a sensible document that’s easy to understand. It reveals various groups of money inflow and outflow sources. Cash flow assessment begins with a report listing incoming cash from all sources-sales revenue, of course, but also separate lines for proceeds from selling company assets, borrowing, and capital infusions from company ownership.

One section of a cash flow statement is operational activities, which shows money received from routine business operations.

Take net income for a given period-such as the last calendar quarter-and add charges for depreciation and amortization that were calculated for tax purposes. Also add increases in accounts payable (or subtract decreases). This accounts for expenses you haven’t paid or bills from past periods that were paid with cash income generated during the current period. Subtract increases in accounts receivable, which is income this period that you haven’t collected. Or add decreases in accounts receivable, which is money from prior period sales you collected in the current period.

The next group is investment activities. This section subtracts money distributed to owners, whether by dividends or other types of capital withdrawals. Add owner capital contributions. In this section, also list purchases of new equipment and property. Lastly, a financing activities section shows funds received from new borrowing or cash used to repay loans.

Free cash flow

The key component of cash flow analysis is the presence or absence of free cash flow. This is the amount of cash the company has on hand after operational and investment activities. The figure presents a better reflection of financial health than after-tax income. It eliminates noncash tax items like depreciation and includes capital purchases for new property and equipment.

An examination of free cash flow from several recent calendar quarters will give you a trend: Consistently negative free cash flow indicates excessive spending-an unsustainable path of insufficient funds that must be altered. Conversely, positive free cash flow is a vital indication of sound financial health.

Cash flow budget

Use your cash flow analysis to develop a cash flow budget. It could show that, in a new project, cash may be required for new equipment before you can collect accounts receivable. Previous cash flow statements demonstrate the relationship between earnings trends and other categories of cash inflow and outflow.

You’ll likely need an accounting professional to devise a cash flow projection using the ratios and trends of the recent past. However, ongoing monitoring of whether you’re on cash track is entirely your responsibility.

Avoid the financial abyss by understanding and watching your business’s cash flow.


Plan Ahead for a Tax Audit: Organize Those Records

Most entrepreneurs are big-picture thinkers rather than dedicated to detail. But these traits needn’t be mutually exclusive: You don’t need to obsess over details to have well-maintained and well-organized business records. And as you know, these are crucial to the health of your business-especially in the event of a tax audit.

A sound recordkeeping system needn’t be intractably complex. It just requires basic rules. If the auditor should knock, you’ll be glad you followed these basic rules to the letter. Of course, you need to keep company tax returns for the past seven years; your tax accountant may have implemented shortcut accounting entries that are revealed in detail on the tax returns.

Also maintain evidence of all asset purchases-equipment, vehicles, and real estate. Include details such as first date of use, cost, and financing. Financial records should always include a depreciation schedule, which lists all capital assets along with depreciation methods and past amounts.

Your records should also include seven years of bank statements, business credit card statements, receipts separated by expense category, and company financial statements. You must keep employment records, such as W-4s, reports of hours worked, wages paid, and taxes withheld and remitted, for each employee for the previous four years.

Despite your focus on the big picture, don’t forget that an organized business not only manages well, but performs well. As well as preparing you for an audit, the process of storing financial and tax records helps you identify fraud and waste and monitor financial progress.