Two things I found out - one I had been doing far too much management accounting which I was not getting paid for, and secondly I had invented my own perfect cash flow forecast and analysis spreadsheet for the minutiae of home economics.
This little video sums it up pretty nicely, and I have been through an hour or so on youtube and really this is the deal anyway! ( the business owner looks and sounds a bit like Scarlett Johansson too)
The most interesting issue is that businesses can actually survive with no profitability far longer than they can without cash flow. When the cash in versus cash out is negative when the last bills come to be paid, then technically the patient is dead: the heart has been deprived of blood and dies: the company is bankrupt.
In fact cash flow analysis and planning will help a profitable company avoid "liquidity" problems or actually going bust, by allowing company to act in the following ways:
1) It is a discipline on actual costs and actual incomes played over a realistic time period, usually quarterly and monthly but also down to bi-weekly.
2) It helps you understand that your gross margin contributions are actually high enough to contribute to positive net working capital, a financial analysis which is really a cash flow analysis plus any saving in cash and assets which could be sold to raise cash in the short term.
3) with one and two in mind, it means that cash reserves can be put aside to
a) stem seasonality in sales income
b) reduce reliance on other "current assets" by making crisis more forseeable or on the radar earlier
c) ensure there is always enough money in the bank to pay bills
d) cover annual or seasonally large "overhead" costs or investment costs
4) taking all into account for a small business or large, it means using analysis tools and planning define and can control the parameters of when the wave of cash comes in from customers and when it goes out to employees, creditors and suppliers.
Good analysis and planning mean that you as said above, plan to have enough cash in the bank to pay your liabilities for that period, and in a struggling business believe me that period is actually defined by the point in the month when you have to pay your employees and you have to pay your bank, because not paying either will lead to a bigger crisis in confidence and law breaking.
For larger businesses cash flow has impact on financial accounting as well as what we are discussing here, management accounting which is operational: a company must actually prove it was profitable usually by presenting annual accounts which include really a summary of start cash and end cash for the year, and total outgoings and total income. There is a huge game to play in getting cash in longer before it must go out again and using "virtual profit" or rolling gross margin to fund a business while creditors are paid on a basis which is delayed to achieve a temporary positive cash flow.
Back then to the topic of WHEN to define your period start and end for a small company- a sensible approach is then to have the start period actually as month end last month and the stop of that period being the day before you have to pay your employees and maybe say a week before you have scheduled to pay your bank loans and any overdraught settlements.
It may seem nice and neat to do it month start to month end but then you are getting into a "nice to have and to look at" cash flow analysis which does not diagnose the patient's health until two weeks after it needed to.
So say that we start month end - we expect to get paid in a 31 day month by all 30 day customers billed in the preceeding month and any work on 14 days closing on the 16th of the month. We then maybe have in that some leeway for electronic bank delays (suspicious net positive cash flow skalduggery in the banking sector!) and actual money in: no issue, as long as we know what we SHOULD get in and that this amount plus starting cash in bank or easily accessed reserves will cover our planned outgoings to say week 3 of the next month, the 21st - the day we file payments to employees and assign monies to pay debts.
Now you see the importance of leeway- in another analogy, we have some wriggle-room here for the small business - we actually have three weeks in which to collect all our income or alternatively, reschedule our debt or raise more cash from or towards working capital.
So we have a discipline of getting money and being nervous about there being enough for quite some time maybe, until we realise how nice it would be to spend less time chasing debt over 2 weeks from customers and cover some potential bad debt from their side too by building up net working capital or gross margin on sales so that we can cut back on accounts receivable and pay more sales people....
Also then, we can then look more at the bigger picture and look at that seasonality or to cover potential down turns while we liquidate assets or reduce costs. Furthermore we may want to use a particularly cash positive period to reduce debt or invest in the business and make ourselves more tax efficient relative to ambitions of the company and net capital worth of the company.
Then we can look at using month start-month end and quarterly instruments which use the same basic information, but then we have actually in a year where we operate effectively 49 weeks, 180 days or so, we reduce the stress on the organisation by 60 days if you like: we have 60 days longer to analyse cash while we know we have enough cash on hand- We can then take extraordinary costs and events into account as just that, and go pleading for longer line of credit from suppliers and new loans from our creditors.
Fundamentally though, for many SME's a three week cash flow analysis cycle-projection, and a quarterly statement to the board of directors (excluding extraodinary events) will help you face the facts of whether your break even analysis was correct based on your initial cost-sales calculations, and what you need to do to pricing or volume of sales to increase income, and what you need to do on the other hand to reduce costs.
The three week discipline is very focused on keeping the bank happy, your employees working and also on just running a tight ship in front of all parties so that you are known as a serious business. It also in fact means that with a reasonably good accounting set up for payable versus receivable and management attention to costs and bills, that if it is delegated away from core entrepreneurial management then the self discipline for the accountants means that they know of the cash flow shortfall by the end of week one of the three weeks, while if the balance is at least made ( banked cash IN equals or exceeds payments out two weeks later), then they can concentrate on those two weeks ahead on final notices to overdue customers and then take the last 2 weeks - ten working days - in collecting accounts receivable to be banked by the start of the next analysis cycle instead of having the two month end tasks collide- ie in week 4 they are preparing an arbitary cash flow from day 1 to day 31 ( or 31 to 31 as some do) at the same time as trying to make it happen.
The period is last working day last month to day of payment, but the analysis point is actually about one week into that three weeks when the balance is reviewed as a health statement to management that this month the heart will at least beat.
In terms of financial reporting to the banks or authorities the cash flow analysis just needs that arbitrary historical data per calendar month which is difference accounts payable cashed to accounts receivable cash. This is then done often quarterly for the board or some authorities and not presented until the data is analysed the in the weeks subsequent to the quarter in the calender being finished.
As you see then, you could easily be lead into arbitrary accounting practices by employing accountants who are too financial accounting oriented- ie counting the beans and calling the score when the game is over, rather than looking at the play on the field at the right times to be able to alert you to a short fall in real ability to pay your people. It is though rather easy to employee people on the right footing to operate in this way in an SME though, or realign an accounting department to be more focused on cash flow.
Really looking at debt ageing and days to payment from receipt goods and so on are academic exercises if you cannot get the lion's share of the money you are owed in on time to pay bills, and use the positive contribution from margin above covering the overhead costs effectively over a longer term to pay large seasonal liabilities, span seasonal low income or fuel more investment in your business.
Suddenly you can find that you have investment money you did not know you had, but remember that you cannot avoid "death and taxes" if there is not cash later: hwoever you can indeed rob Peter to pay Paul using cash flow. You can gain a lot of investment money by stretching your cash flow out - longer terms for suppliers, shorter terms and cash % of full work on commencement
Take two of the many SME's I have worked with:
1) The effective CEO ( being banned from being a director) in one business services company said openly to we in management that we used suppliers to fund the business- ie we had the net flow of cash in with the gross margin on top, way before we paid them. We would borrow short term from them by either having goof lines of credit, or avoiding paying them and then paying small interest payments on each bill. Further to this, any mistakes we could correct and "sell out" anyway, were disputed such that those outgoings were frozen relative to the actual income we managed to get.
2) In the drinks importer and distributor, we had a good deal of customers on account- that is to say a consolidated month end bill with 30 days to pay. Now, you can believe that the first working days of the new month were hectic, because they would stock up to hell with beer and spirits knowing they had about 55 days to bank the money before they paid us, and then in the mid nineties, they still had " the cheque is in the post love" to reply when challenged beyond 60 days.
On the internal side though, for all those "debtors" we had a CFO meeting every bloody friday afternoon to see who had not paid and who would not receive any more stock until they paid their terms. This was a discipline also on the "lion's share" of the incoming cash to the cash flow too as larger accounts were confirmed payed or expected each and every week. Now the bar and club sector was run by enough independent wide boys and sharp small chain owners to mean that you had to stop any more sales to some and offer poorer credit as soon as they went over their line of payment and limits were set to many's accounts until they showed they could pay.
As first an account manager and then a project manager and later a specialist consultant in marketing, I was never really that exposed to cash flow until companies were at death's door. I saw it as boring, while being more interested in having enough resources and quality to deliver on time to the customer such that we could bill out on time-. that much is true! However the topic may be dull, but having a grip on the realities of it will help you be a more respected manager in an SME and of course if you become an entrepreneur, you will have the attitude to be disciplined as hell about positive cash flow and being able to show your financial backers that you have a solvent, viable business running to plan or at least sustainable.
As I mentioned at the start, for my HOME economy, I divised on my own back based on a revenue analysis P/L statement actual start-end cash flows with an idea of potential bank balances at period start and end.
I should have done this on a shorter period that the calender month at some points in time, because it came down to panicing! However luckily income as an employee is 99% predictable for each quarter forward given I get usually 3 months notice in the contract, and bills etc are at predictable time points, with history from several years, and they have a line of credit which allows for some robbing peter to pay paul.