Cash Flow Planning


We have all heard the expression that cash flow is king. Cash flow provides the funds necessary to pay your bills, including purchase supplies, pay employees, and keep your business operating it is the money coming in and out of your business. Most small businesses operate in an environment of irregular cash flows against limited cash liquidity, or availability. Ultimately, you need cash  on hand to pay bills and keep your business running

Cash flow is more important to a business than profit because your cash position determines a business’ capacity to pay the bills, including debt. Investors and banks know this, and as a result, they will use a business’ cash position to determine the business’ value and credit worthiness. 

How can you avoid having no cash on hand? How do you plan for cash flow irregularities?

The storycan you relate?

cash flow 1

Meet Joe.  Joe has worked hard building sales around his retail bike shop. He’s been open a few years and has seen steady growth year over year. But right now, he wishes he had understood some basic points about the importance of cash flow planning.

Joe tried to get a line of credit for his inventory with vendors but was refused because he was still a young business.  He was able to get a term loan instead and used it to purchase inventory. 

Supply chain issues made it difficult to get that inventory, so in the meantime he also used the term loan as working capital. Because the delays in the product supply chain made him worry, Joe ordered more inventory than he normally may have done in the past. 

Sales were booming over the summer and so he decided to pay off a large portion of the outstanding debt in advance.  Since then, however, sales have slowed due to seasonality. Now his working capital is tied up in his over stocked inventory. 

Although it felt good to get rid some of the outstanding debt, it has left him short on cash to bridge the slow season.  Now he is in a pinch to cover expenses he incurs on a routine basis like rentutilities, and contracted staff - such as his bookkeeper.

Solutions

What could he have done differently?

1.  Before borrowing money, it is important to put together a simple cash flow projection. This exercise will help the business owner decide if there is capacity within the business to pay back the debt.  

2. Understanding seasonality is important for understanding cash flow. Joe should have waited for a full business cycle (usually 1 year) to determine how and when to pre-pay debt. In a start-up that cycle is longer.

3.  Your banking connection is one of the most important relationships to a small business. Keeping your banker in the loop by delivering on agreed upon financial statements is important. It is also vital to inform your bank about any difficulties the business might be experiencing because your financial institution wants you to succeed and can work with you; they might be able to defer some of the debt.

4. Lines of credit should be used for short term needs, such as inventory, seasonal revenue fluctuations and working capital. Joe was correct in seeking a line of credit for inventory, but taking out a term note for inventory was not a good use of those funds.

One of the major reasons for business failure is a lack of capital. Just like a car needs fuel, a business needs cash. The NH SBDC has a short, no cost eCourse on Understanding Your Cash Flow Statement. Click here to take this short course, which contains links to resources such as an Excel cash flow template.

Understanding cash flow is vital to managing any size business.

Author(s)

Andrea O'Brien
Director, Business Sustainability Program & Business Advisor
Phone: 603-641-4379
Office: UNH Manchester, others by appt. 88 Commercial St. Manchester, NH 03101

Warren Daniel
Business Advisor
Phone: Office (603) 862-2200
Office: UNH Peter T. Paul College of Business & Economics 10 Garrison Avenue, #270N Durham, NH 03824
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