The Basics to Approaching Cash Management

Knowing that cash is important to a business is as basic as understanding that fire is hot. Despite awareness of these facts, running low on funds is a common way of getting burned by cash management problems. Some cash crunches are unexpected, but many are avoidable. Averting common cash management mistakes is key to preventing disaster.

Collecting Revenue

Unless a business has retail customers who pay at the time of sale, it will have accounts receivable to manage. Reviewing what’s owed should occur routinely. Examination each week is advisable. An invoice should never age beyond the due date. A customer who is merely one day late should be contacted personally.

Immediate payment and future promptness are most likely to occur with a polite phone call. Sometimes a customer simply forgot about paying an invoice. Customers with cash flow problems are often embarrassed by their situations. Arranging a partial payment and an installment plan will ease their concerns. The focus of a sound collection system is providing predictable cash flow that sustains the organization.

Managing Costs

Bills for some things arrive every month. But a lot of business expenses are incurred at various times during the year. A little income each month must be set aside for paying the bills received in only some months. This cash management is easily administered with a general budget that conveys when these nonrecurring costs are due. A little cash must also be conserved for surprise events, such as replacing broken or worn-out equipment.

Most important of all, payroll expenses should never become a burden. This is not an expense that sneaks up on a business. Enough money for paying staff as well as contract workers must always be set aside in advance. Especially vital is including payroll tax deposits in cash planning.

Efficient personnel management is essential to minimizing payroll expenses. This requires planning for work that lies ahead and appropriately scheduling workers.

Spending Errors

An entrepreneur can accidentally succumb to impulse spending that strays off course in the same way a person may blow a family budget. A mindset to resist unnecessary purchases is crucial. You want every purchase aimed at increasing productivity.

For example, stocking up on inventory or supplies at discounted prices may appear beneficial, but that’s not true when it triggers a cash shortage. Bulk purchases are not worthwhile if they crimp business cash. They eliminate the funds necessary for more important actions that result in higher revenue.

Another common temptation to resist is purchasing the latest tech gadgets. Upgrades to business technology should be planned in advance as part of forecasted expenditures in the upcoming year. System replacements are typically only necessary every few years.

Similarly, paying vendors early to obtain discounts might be unadvisable. This can sabotage your objective of holding cash for immediate needs. In fact, a cash shortage may arise that necessitates late payment. By communicating these setbacks immediately to vendors, a business owner is able to explain the temporary difficulty and commit to a promised payment date in the future.

Financial Reports Can Uncover Business Improvements

Business financial statements deliver a record of past events and, more importantly, reveal the direction you’re going in. Examining a few factors within the numbers will show you how to control your destination.

A key area to evaluate among multiple periods is the past fluctuation in revenue based on various amounts of spending for marketing, labor and perhaps other categories of expenditure. For instance, see if periods when you spent more on your website resulted in subsequent months of rising revenue. Or maybe your sales tended to rise when you increased business meal expenses by taking more customers to lunch. The key is to repeat actions that enhanced revenue and avoid spending on things that were not fruitful.

Another useful measure is revenue per dollar of labor expense. A solo operator may simply examine revenue per hour, since an entrepreneur devotes time rather than money to attaining revenue. Shifts in these ratios inform you about the productivity of staff or independent contractors or even yourself. A falling ratio of revenue to labor cost may indicate you have excess staff. Perhaps projects are assigned to the wrong personnel or presented without sufficient instructions. Maybe your business has outdated equipment and making new purchases would enhance labor efficiency.

Find out if variances in revenue are the result of selling more to each customer or a change in the number of customers. To measure this, divide revenue by the number of customers. If you sell many things to a broad market, you’ll benefit from monitoring the gross profit margin of each product or service sold. Discussing ratios with your accountant will assure that you make optimal use of financial statements rather than rely on gut feeling.

The Least Challenging Way of Business Budgeting

Creating a useful small business budget is typically so frustrating that entrepreneurs tend to avoid the process. Unfortunately, a mere hope for a favorable future is likely to trigger even greater frustration and possible catastrophe. Thinking about how a budget is a means to a satisfying end will help you tackle the process with conviction.

Business Budgeting Mindset

Setting a budget is less daunting when you realize that the results are simply an outline of your business. The utility of this should not be underestimated. By focusing on the ultimate purpose of the budget, the effort of putting numbers on a page is not viewed as a burden. Finishing the budget is not your objective. Having a valuable tool to guide your future is the real intent.

The budget you create is a way of controlling sustained growth. The budget timeline shows a pace that permits always having sufficient capital to acquire the resources necessary for meeting sales targets. You know from the budget how much spending for marketing, equipment, staff and materials will precede revenue generation.

Getting Started on a Budget

A useful budget starts with careful scrutiny of costs required to produce projected sales. The essential feature of a budget is forecasting the length of time between paying costs and collecting revenue.

Utilize reliable sources for budgeted costs and timeline. Input from a management team is crucial, if you have one. Your accountant is also a valuable resource for turning your rough estimates into realistic projections. A precise budget isn’t as important as having a sensible direction for future business decisions.

Don’t drive yourself crazy by making exact forecasting calculations. The budget is merely a compass that should be sufficient for guiding your general spending habits and predicting the sales revenue that should be realized.

Using a Business Budget

Comparing the business budget to unfolding reality reveals variances so you can adjust spending. When unanticipated events arise, you can look for expenditures to reduce. Within the budget, you will find expense categories to cut that are least likely to sacrifice sales. Also possible to occur is an unusual purchase opportunity, such as acquiring business necessities at a discount. By referring to your budget, you uncover whether a tempting purchase will wreck cash flow or improve profitability. Always looks for avenues to maximize future profit without hampering funds needed to sustain current operations.

Predictions about the future are always difficult. But your budgeting accuracy will improve with practice. A sound technique for some enterprises is creating a budget only for the next couple of calendar quarters or a few specific projects. After comparing the actual results to the budget, you learn how to revise a better forecast. This exercise soon makes your budgets more accurate and reliable. You learn more about realistic delivery dates based on your cash and other resources.

Most importantly, as you find that a business budget helps you complete work on time and sustain all business spending, the entire forecasting procedure becomes a comforting endeavor rather than an overwhelming burden.

The Easy Way to Track Business Petty Cash

Small businesses typically hold some amount of petty cash as a convenience for making minor purchases, particularly when reimbursing employees. But even a solo entrepreneur is likely to withdraw some cash from the business bank account to pay nominal expenditures, such as coffee with a client.

One of the problems with petty cash is properly accounting for its uses. This is accomplished by a simple system for tracking cash disbursements and replenishing the money. Withdrawals from petty cash should be replaced with receipts equaling the amount of funds spent.

Periodically, the receipts are collected and a bookkeeping exercise is conducted to reduce petty cash and increase the expenses paid. The sum of remaining cash and the expenses should equal the original amount of petty cash. If there’s more money than expected, funds must have been transferred from the business bank account or the enterprise is an operation with some customers paying cash.

Businesses that hand petty cash to employees must make the workers accountable for how the money is spent. While an employee has the money, a note should be placed with petty cash stating who has the funds along with the amount and date advanced. The employee should return later with receipts and the unspent cash. This procedure permits the business to record the expenses as if it had paid them directly. Similarly, an employee may turn in a receipt and obtain a reimbursement from petty cash. That method also allows the business to deduct the expense paid by the employee. Since the cash outflow is recorded as a business expense, the amounts are not being paid as wages, and therefore the employees don’t incur personal compensation.

Some Business Costs Are Not Recorded as Expenses

Learning one basic rule about business expenditures will vastly improve bookkeeping accuracy and avoid tax-reporting mistakes. This standard is simply the fact that some (but not all) purchases of items used in business are not expenses. These exceptions are assets.

Recording Assets

Business assets appear on the balance sheet, which is a key component of your financial statements. By contrast, the income statement has the incomplete picture of only revenue and expenses. The balance sheet shows you what happened to profit that remained after paying expenses with revenue. Over time, the balance sheet may indicate that profit was used to increase funds in the bank account or repay loans. Another use of profit is acquisition of fixed assets, such as new equipment, machinery or building improvements.

Great care is necessary to identify expenditures that should be classified as fixed assets on the balance sheet. Most importantly, accounting help may be necessary when you borrow money to acquire a fixed asset. The entire asset cost and loan amount are recorded. Loan payments are therefore not expenses or asset additions. They are reductions in the loan balances on the balance sheet.

Fixed Asset Tax Classification

Improperly recording an asset purchase as an expense results in understated profit. This upsets tax planning. For income tax purposes, the costs of fixed assets are deducted as depreciation over time. Complicating this matter is the variety of periods over which different types of assets are depreciated. Your accountant therefore needs not only the cost for a fixed asset but also a description and the date when it was first used in business.

As a general rule, depreciable fixed assets are property with a useful life of more than one year. But small assets are an exception. A screwdriver, for example, may be an office expense on the income statement, although it will last for more than a year. But a programmable robotic assembly machine should be classified as a fixed asset on the balance sheet.

The threshold amount that identifies when a purchase qualifies for expensing tends to vary based on business size. For small businesses, the U.S. Internal Revenue Service generally permits an expense deduction for any single item with a cost of less than $2,500. Anything with a greater cost and a useful life exceeding one year should be classified as a fixed asset. Its cost is then depreciated over the allowable length of time permitted by the tax rules for the type of property.

Additions to Asset Value

An especially complicated purchase to classify is an improvement to an existing asset. Expenditures that improve property are categorized as new assets. Improvements to buildings are the most common area of confusion. But the issue also applies to machinery.

In general, a cost that merely makes something operate better is an expense. Conversely, you’ve acquired an asset when you spend money that adds to the life of a property, expands its size or is crucial to its functionality. For instance, fixing a hole in the ceiling may be a repair expense, but replacing the entire roof is likely considered an asset. The IRS has threshold amounts to distinguish repair expenses from improvement assets. These quantities vary based on multiple factors. So checking with your accountant about the numbers that apply to your business is the ideal route for avoiding errors.

Considerations for Accurate Payroll Preparation

The greatest bookkeeping challenge for most small business owners is preparation of payroll. This is often the case even when the only worker is the owner and the business is incorporated. The corporate enterprise must treat the owner as both employee and shareholder.

Computation of payroll taxes as well as other paycheck additions or subtractions is tedious and complex. Many entrepreneurs outsource the function to payroll services. A substantial number of business owners deploy internal computer payroll applications. These platforms commonly interface with the company’s general bookkeeping system. Unfortunately, this frequently leads to a false sense of security that accurate accounting for payroll is automatic.

Careful input of employee data and details for each pay date is a manual process requiring great care. Scrutiny of the resulting payroll reports is a crucial step to assure the correct amounts and types of payroll taxes are determined and remitted. Most importantly, diligent examination of the business’s financial statements is essential for assuring that the payroll data has imported accurately to the bookkeeping accounts.

Periodic comparison of payroll information to the business financial statements is the best procedure for averting payroll accounting problems. This examination necessitates having both the company balance sheet and income statement as well as the payroll data. The income statement should have an expense account showing the amount of gross wages paid before employee taxes and other deductions. The expense account for payroll taxes should indicate the employer’s taxes only. The balance sheet will have liability accounts for deductions from employee paychecks and the employer share of taxes.

Addressing New Year Business Financial Issues

The beginning of a new year is when small business owners plan for what lies ahead and consider lessons learned from looking backward. Especially important is the imminent matter of addressing income tax for the year that recently ended. You should, however, already have a solid understanding of your tax situation by having relied on accountant advice throughout the year. Unfortunately, achieving this standard can be frustrated by lax recordkeeping. Therefore, a new year is ideal for implementing improvements.

Financial Records Precision

Dig deeply into your business financial statements of the past year. Don’t merely glance at the bottom line on the income statement. Scrutinize every number. Assure that each asset, liability and expense amount makes sense. If anything isn’t clear, find the source of questionable items.

Keeping mounds of receipts, invoices, and bank statements is certainly a hassle. Moreover, the flaws in this system are magnified by having to locate a past detail in a pile of papers. Investing in a good scanner for saving electronic copies of everything is a far superior method. If you already have electronic files, make improvements to document labeling and folder organization.

The most crucial vow for a new year is assuring that all transactions are recorded in a timely way. Details needed for accurate bookkeeping should be assembled immediately after events occur. Collecting information for tracking every business activity without delay assures that financial records are complete and accurate.

Business Planning Mastery

Planning for a new year relies heavily on data from the recent past. You don’t want to blindly make decisions for the future. The planning process is therefore delayed if you’re waiting for several weeks (or even worse, a few months) to get necessary financial statements.

Forecasting the year ahead requires knowing your present working capital and cash flow. Your financial capabilities inform you about how much you can spend. The business balance sheet shows cash available and unpaid bills if you’ve kept your records up to date. This report also conveys existing debt so you can identify possible additional borrowing capacity without burdening the company.

A cash flow statement or cash basis income statement illustrates where business revenue has been going. With this tool, you can plan for new spending initiatives. This, of course, means having a sufficiently positive cash flow. If you don’t have enough cash flow for spending on your business growth strategy, the income statement tells you the recent amounts spent in each expenditure category. This guides you toward potential areas to cut back in.

Tax Savings

Tax reduction strategies are also identified from timely and accurate financial statements. For example, your accountant can advise you about retirement plans. The contributions are tax-deductible, and the amounts going to your personal plan account are essentially payments to your future self.

Business health insurance plans can also save money. In fact, many types of benefit plans are allowed under the tax rules as business expenses. But creating and administering them comes with a cost. Determining whether advantages outweigh the costs necessitates careful analysis of business financial circumstances. So everything comes back to organized files and mastery of financial statements.

Conducting Financial Tracking of Business Phases

A fact confronting all entrepreneurs is that everything in business will not stay constant. Conditions are always changing. Although some changes arise suddenly and unexpectedly, every business goes through four general phases. The key to survival is recognizing what phase you’re in and avoiding regression.

The first phase is starting the business and funding it with personal cash. Your goal of making money can’t happen without initial working capital. This pays for things needed to accomplish the work that ultimately generates revenue. Insufficient beginning capital is a primary reason for business failure. You likely need twice as much startup funds as you thought, and phase one will probably last twice as long as you expected.

In the next phase, you’re gaining sales, but the business isn’t generating enough cash to pay all the bills. You’re still using startup capital plus spending incoming cash to fund further growth. You want to move through this stage quickly before depleting all your capital resources. In phase three, the business finally has sufficient cash flow to pay you. This is when advice from an accountant will help determine how much owner compensation the business can afford. More importantly, tax planning in this phase is valuable.

In phase four, the business can finally give you a recurring paycheck. The business still has profit after paying you. That permits the business to fund your retirement, expand or have increasing value to a potential buyer. This situation may last for years, but don’t panic when changing conditions compel stepping backwards for a while. Remember to evaluate financial statements to understand your business phase.

Time to Scrutinize Your Business Financial Details

Changing economic conditions are the greatest stimulus to urgently determining the best course of future action. To identify the most crucial matters to address, you must first know how to read and understand your business financial statements.

Assets & Liabilities

The collection of reports comprising business financial statements provides a complete picture of the cash flow and overall condition of your enterprise. Most importantly, the balance sheet is a reporting of business assets and liabilities, with the difference between these two factors being the equity you’ve built over time in your business.

Too many business owners only examine the income statement for revenue and profit. Those factors transform into a deeper meaning by scrutinizing key elements on the balance sheet. A major detail to easily spot as a red flag is higher liabilities than assets. This means your business owes more than it owns. Even if this troubling condition does not exist, you want to evaluate if your business is headed in that direction. This is simply accomplished by comparing over time the ratio of debt to equity. A rise in this metric signals potential problems ahead.

A corollary issue uncovered by the balance sheet is the expansion of accounts receivable or inventory relative to sales. Having too much in uncollected accounts receivable can mean insufficient cash for timely payment of billed expenses. Although possessing enough inventory is important, having too much wastefully ties up your cash. Trends for accounts receivable and inventory can also be assessed by ratios. These determine the number of days you have on hand of accounts receivable and inventory based on recent sales. Since these calculations demand a little experience in analysis, your accountant can help with the math. All you need for this exercise is accurate up-to-date bookkeeping.

Revenue & Expenses

The income statement is the familiar report of revenue and business expenses. Many small operations keep their books on a cash basis, meaning the income statement reports revenue when received and expenses when paid. If your enterprise is accrual-based, it records revenue when customers are invoiced and expenses when bills are received. An accrual-basis operation will, therefore, also need a cash flow statement.

Declining revenue is obviously bad. But a temporary period of falling sales can be survived with some expense reductions or borrowing money. Look for unnecessary expenditures that can be reduced or eliminated. Your business may be stuck with large costs for space and personnel, but other categories are ripe for cutting back. Lower spending for multiple small categories can add up to substantial improvement in cash flow.

Deciding whether taking on more debt is sound brings you back to the balance sheet. If your business has plenty of equity, having more liabilities will not harm the operation’s financial strength. The other consideration with borrowing is assuring sufficient cash flow for loan repayment. Finding your cash flow number, which is not necessarily the business profit, permits you to calculate the sufficiency of incoming funds to cover the sum of all loan payments. That’s another simple ratio but also a factor to consider with input from your accountant.

Have a Meeting with Yourself about Cash Flow

When you perform all the executive-level functions at your business, the important role of officer meetings, such as those at large enterprises, is overlooked. But a few intervals throughout the year are ideal for requiring your inner CFO to describe cash flow results to an empty room of imaginary executives. You’ll force yourself to articulate key money matters. This prevents them from remaining mere abstract concepts in the dark recesses of your mind.

Cash flow is different than profit. Cash flow from operations ignores uncollected revenue and unpaid expenses. These elements are identified on a cash flow statement as the changes in accounts receivable and accounts payable. You then add or subtract other factors from operating cash flow. Interest expenses and depreciation are added. Costs for depreciable assets are subtracted. Loan payments are also subtracted. Any money that’s borrowed or that you put into the enterprise as an owner adds to cash flow.

A cash flow statement is a key report, but some smaller operations already maintain cash basis bookkeeping. In those cases, cash flow from operations can be identified from the cash basis income statement, which already excludes uncollected income that’s still in accounts receivable and unpaid expenses that are still in accounts payable.

Comparing cash flow from one period to another delivers insight into the overall financial health of the business. Although rising cash flow is generally good, building too much cash may indicate excessive borrowing, not paying bills on time, or ignoring replacement of old equipment. Short-term cash flow dips are not so bad if they result from increasing revenue that’s not yet collected.