The current ratio Quick Ratio in historical cash balances are all useful estimates of whether you need
a loan or some other source of funding in the future.
The biggest weakness is that they are all backwards looking.
All decisions are based on the future and require analysis of expectations of that future.
There is a reason the windshield of your car is bigger than your rear view mirror drive your company
by focusing on what's ahead of you.
The gold standard for estimating your need for loan funds is a cash flow projection.
I'll talk you through how to create one a cash flow projection template is also included in the course
contents.
Before we get into creating a cash flow projection I want to explain how cash flows in and out of your
company think of managing your company's cash as coordinating three tanks of liquid.
In fact a company has access to cash is often referred to as its liquidity.
There are three main sources and uses of cash.
Think of each as a tank of cash investments.
The investing tank is the amount of money your current and potential owners have available to invest
in the company the operations tank is your business is checking account the amount of cash in the tank
rises and falls with the cash conversion cycle.
The financing tank is the money you can borrow from banks friends and family.
A business starts when the owners transfer their liquid cash to the operations tank.
The business spends this cash for operations reducing the tank.
Soon the business produces a return on the cash which starts to fill the tank backup.
Successful businesses have so much cash coming into the tank that they can flow it back to the owners
or make big investments for growth.
Once lenders are confident that you can keep your operations tank filled they are willing to allow you
to tap into their tank of funds when you need it.
Now the owners tank isn't the only spare tank available when you need it for cash for growth or investment.
A cash crunch happens when the operations tank is draining and the owners have already drained everything
they had in their investment tank.
Lenders get concerned that they won't get their money back from the company so they shut off their pipeline
of cash to the company.
I was a bank CFO during the Great Recession and saw companies get into this cash crunch situation.
Ironically what often caused the cash crunches were good economic times.
Owners saw lots of opportunities to make profits in their companies.
They drained all their personal cash reserves into the company.
At the same time they borrowed all they could and made big investments.
Everything worked as long as the economy allowed the operations tank to quickly refill with cash.
However the economy repeatedly goes up and then goes down when it goes down the operations tank fills
much more slowly with no reserves in the investment tank and no more access to the borrowing tanks.
The operation tank went down the expense drain our natural optimism as business owners continued to
see opportunities.
Always keep some reserves in the investment and financing tanks you may need it for business downturns
or unexpected opportunities.
You need cash reserves when you start a growth strategy.
The three tanks of cash are the same categories on your statement of cash flows the Statement of Cash
Flows provides a historical look at where cash came from and where it went.
Operational cash flows or sales outflows or most of the expenses on the income statement also known
as the profit loss statement.
One interesting note in cash outflows is that interest paid on loans are included with cash from operations
not cash from financing or the principal portion of the loan payments go.
This was subject to a contentious debate when the FAS B who makes U.S. accounting rules required the
addition of a statement of cash flows for audited financial statements in 1987.
You can make a case for it being an operations or financing but fast B said financing and so that's
where it goes.
Investing cash flows are used for things like buildings and equipment investments like stocks and bonds
are also investment cash flows financing cash flows where bank loans go advances or proceeds from bank
loans or cash inflows.
The principal payments on loans are cash outflows.
This is a summarized format for the cash flow statement.
It starts with net cash from operations followed by net cash from investing and financing activities.
You can learn a lot by looking at net cash from operations.
If it's negative it means your company's core operations didn't produce positive cash flow.
You can be profitable but still be bleeding cash.
The negative cash from operations needs covered by your beginning cash balance or by net inflows from
investing or financing.
Another common thing to see on a statement of cash flows is a big cash outflow for buildings or equipment
and a big cash inflow in net cash from financing from the loan to buy those investments.
The three cash flow categories in this summarized statement format are the same three categories that
will be used to my cash projection template all the information you gathered from earlier slides on
historical cash flows can now be used to project future cash flows.
The Course materials include a cash flow projection template.
I can't fit the whole template in one slide so I've broken it into sections that I'll discuss in the
next few slides.
This isn't a course on the specifics of preparing the Statement of Cash Flows or cash flow projections.
So I'm not going into each line item.
I will show the importance of each section and how to use the projection to determine whether you may
need a loan.
The first line of the projection is you're beginning cash balance the beginning cash balance for the
first column of numbers is the cash balance from your accounting software the beginning balance for
all other columns is the ending cash balance from the previous column.
As we work our way to the bottom of the projection I'll show you where those numbers come from you want
to check this balance for each time period of the projection to make sure it doesn't drop below a level
you are comfortable with.
This sample projection uses monthly time periods but you can do projections by weeks months quarters
or years.
The tighter your cash the shorter the periods you want to project.
For example you would prepare this for the next six weeks if your cash is tight and your cash balances
significantly rise and fall within a month.
The first section shown here lists operational cash inflows.
The vast majority of which are usually cash received from the sales of goods or services the next section
are operational cash outflows the sum of all your operational cash inflows and cash outflows total your
net cash from operations.
This total is very important.
It tells you if your business is producing positive cash flow from your standard operations you must
find supplemental sources of cash for the company.
If you have negative cash flow from operations positive operational cash flows allow you to make large
purchases pay down loans or distribute cash to owners many cash flow projection templates ignore or
don't breakout two very important types of Cash Flows financing cash flows and equity cash flows.
You need to understand your operational cash flows before you can start planning your financing and
equity cash flows.
I recommend first entering the rows for our cash from operations section and any required finance payments
in the financing section.
You now have critical information to make major financial planning decisions.
Do you have negative operational cash flow or not enough cash for a large investment.
This is where you would project how much cash you would need from borrowing money or having the owners
invest more equity into the company.
The sooner you can identify potential cash issues the more options you have to adjust your cash flows
to minimize those issues.
Preparing a cash projection provides you precious time to line up loans.
You don't want to be scrambling with tight cash or working against a deadline to get a loan in place
before you run out of cash or miss an opportunity.
The projection estimates when you will need the funds and you can work with your banker to start the
process of getting those funds.
It may even show you have a little time to wait before you start the loan application process.
What if you have a positive net cash flow from operations.
Congratulations you have some exciting options for how to use that cash.
You can't invest it back in the business pay down lines of credit or make large principal payments on
other loans.
You could purchase equipment or distribute the cash to owners.
The sample company above projected meeting in advance on their line of credit in January.
They could then pay that off in April which is good to model.
As I'll explain later you need to periodically pay a line of credit to zero according to the loan agreement.
I cannot overemphasize how important a cash flow projection is to business planning your lender will
want a cash projection for the loan application but don't look at it as just another form to fill out.
It could be what allows you to seize opportunities that you might have otherwise had to pass on.