Where Is the Cash? If I made that much, where is it?
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Where Is the Cash? If I made that much, where is it?

Where Is the Cash? If I made that much, where is it?

Soon you will receive your 2020 tax return from your accountant and happily put the final piece of the challenging 2020 financial puzzle in place. The conversation might go like this:

“Congratulations! You’ve made a profit. And by the way, that means your tax deposit is due on April 15.” Stunned because your bank account says otherwise, you reply, “Well that’s a surprise. If I made that much money, where is it?”

Why doesn’t net profit correlate to an increase in your cash balance? Because profit and cash are not the same thing. 

The accrual basis of accounting provides the most accurate picture of profitability, so most businesses use it to produce their financial statements. Still, “Where is the cash?” can be a mystery for many statement readers. Why? Because while the accrual basis income statement measures profit accurately, it does <not> provide a clear picture of cash flow.

So where did the cash go? The balance sheet holds the clues, but it only shows a snapshot of what is left at the end of the period—without detailing the movement of cash through the period under review. The <statement of cash flow> unlocks the clues by measuring cash in and/or cash out through these functional areas of the business:

  1. Operating (revenue, expenses, resale inventory, accounts receivable, accounts payable, and short-term financing like credit lines or credit cards)
  2. Investing (purchases or sales of inventory, facility expansion, or other long-term investment)
  3. Financing (new borrowing and repaying existing debt)

This statement is on our list of “must haves” because it clearly identifies the differences between profit and cash for any business and shows the impact all business activities have on cash. Yet, monthly or even annual reviews of the statement of cash flow are rare, because it can be challenging to understand until you have some practice with it. The chart details how the statement of cash flow answers the question, “Where is the cash?”

 

Cash In

Cash Out

 

Operating

Net Profit

Net Loss

Income Statement

Decreases in

  • Resale inventory (liquidate)
  • Accounts receivable (collect)
  • Other current assets (liquidate)

Increases in

  • Resale inventory (purchase)
  • Accounts receivable (advance)
  • Other current assets (deposit/pay)

Balance Sheet

Increases in

  • Accounts payable (borrow)
  • Credit lines/credit cards (borrow)
  • Other current liabilities (borrow)

Decreases in

  • Accounts payable (pay back)
  • Credit lines/credit cards (pay back)
  • Other current liabilities (pay back)

Investing

Decreases in

  • Accumulated depreciation (add back non-cash expense)
  • Fixed assets (disposals)
  • Other assets (collect or liquidate)

Increases in

  • Fixed assets (buy/acquire)
  • Other assets (buy/acquire)

Financing

Increases in

  • Owner loans (borrowing)
  • Long-term debt (borrow)
  • Equity (contributions)

Decreases in

  • Owner loans (repayments)
  • Long-term debt (payments)
  • Equity (distributions)

The income statement shows all revenues, expenses, and the “bottom line” difference between the two, i.e., your net profit. Many things other than expenses consume cash, and businesses receive money for things other than revenue. The chart outlines the many things on the balance sheet that have an impact on cash. Those familiar with the statement of cash flow will recognize these categories. The statement shows the beginning balance of cash and then details the amount provided by or consumed by operating, investing, and financing activities of the business, to arrive at the ending balance of cash. This is how the statement answers the question, “Where is the cash?”

WHY DO THIS?

How do you avoid similar surprises in the future? By creating a <monthly cash budget> to accompany your income statement budget.

A monthly cash budget is constructed by estimating forecasts (assumptions) for the items outlined in the statement of cash flow. For most companies, it is essential to predict inventory purchases, credit and collection patterns, equipment purchases, expansion investments, borrowing, debt repayments and distributions to owners (particularly important for LLCs and S corporations that pay owners amounts that don’t appear on a W-2). These items are typically not on the income statement budget, but they will consume your future cash flow. 

With budgets for both profit and cash, you are armed with two powerful tools for planning and control that no business should be without.

Our new Budget Playbook details a process for building a cash budget, and for using your budgets to negotiate and plan for financing your business. This is just as important for businesses that are experiencing a sales tsunami as it is for those experiencing losses from a challenging market. The Playbook is free to download at our website.

To make a realistic forecast, get help from a professional. Even if you are an accountant yourself, another perspective is helpful, from both the technical side of how your cash flow spreadsheet is set up, and from the common-sense side, providing a reality check for your assumptions.

SUMMARY

These disciplines can help you understand and predict your cash flow needs, assuring that you will have the funds available when you need them.

  1. Review financial statements and cash flow ratios regularly, including the statement of cash flow.
  2. Prepare a rolling 12-month income statement budget that accounts for seasonality to serve as your profit plan.
  3. Prepare a rolling 12-month cash budget that accounts for all cash in and cash out to predict potential cash shortages and borrowing needs.
  4. Use the cash budget and profit plan to negotiate for financing well in advance of the time you will need the funds.

The most successful business owners take advantage of every opportunity to manage better and improve their operations. If you are ready to raise the bar on your financial review routines, make the statement of cash flow and a cash budget a management standard.

Barbara Nuss is the president and founder of Profit Soup, a financial education organization specializing in providing services to franchisors and franchisees to enable them to trust their numbers, focus on priorities, make better decisions, and earn more profit. Learn more at www.profitsoup.com or call 206-282-3888.

Published: July 10th, 2021

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