You can't manage what you can't measure
As a business owner, understanding your cash flow is like having spidey senses…. If you're a new business owner looking to take charge of your cash flow and make smarter decisions, then this blog is for you.
A cashflow report is nothing more than a summary of all the money that goes in and out of your business. It tells you how much money you made, how much you spent, and how much you have left over. This is important because it helps you know if you're making or losing money and more importantly where is the money coming from/going to.
Your cashflow report can be found in your accounting software or in a spreadsheet you made yourself (here’s a template in case its helpful). If you're not using any software yet, it's a good idea to start. This will save you time and effort in the long run, and you'll be able to make better decisions for your business.
Reading your cashflow report may seem daunting at first, but it's actually pretty simple. There are four main parts to it:
The cash flow statement begins with net earnings, which is the money left over after paying all your business expenses. This comes from your P&L statement.
For example:
- Your gym makes $20,000
- You spend $15,000 on expenses
- You have $5,000 left. (this is your net earnings)
Knowing your net earnings is important because it's the starting point for understanding your cash flow.
Now, let's see some things that can make your cash flow go up. These are changes to your net earnings based on transactions that don't use cash.
On your P&L there is a way to spread the cost of something you buy for your business over its useful life.
Let's say you buy a $10,000 treadmill that lasts five years and would cost $2,000 per year. On your P&L this reflects as $2,000 reduced from your net earnings.
However, whether or not you’ve paid for it already, the $2,000 of ”depreciation” isn’t a line item. If you pay all $10,000 today, its not like you’re paying an additional $2,000 of depreciation. Similarly, if you pay for the treadmill in a month, its not like $2,000 has actually come out of your bank account
Finally, if you pay $5,000 out of pocket and use a loan of $5,000, you’re not spending another $2,000. In this case, the $5,000 you put in would be an “increase in inventory,” and the $5,000 loan would be “loans payable” both of which we’ll explain down the line.
At the end of the day, this $2,000 is not actually leaving your bank so we add it back in to the cashflow statement.
When customers pay you, your AR goes down, and your cash flow goes up. For example, if gym members pay $3,000 in overdue membership fees, this would already have been in your P&L but its not on your cash flow statement.
Since you've actually received the $3,000, you can add it to your cash flow
If you owe money to suppliers, your AP goes up. Since you haven't paid yet, you still have more cash. For example, if you owe $1,000 on $2,000 of cleaning supplies, your P&L (and your net earnings) already accounts for $2,000 of expenses.
Since you've only actually spent $1,000 you add the $1,000 you have yet to pay into your cash flow.
Remember, this is technically still money you can use, but you should only use it if you know it'll make you more than $1,000 by the time you have to pay the owed amount.
Like AP, if you owe more taxes, and you haven't paid yet, you still have more cash on hand. For example, if your gym owes $500 more in taxes, you add that to your cash flow statement.
Again remember that you actually owe this money so you should never invest it in something where the returns are a coin toss.
Next, let's see what can make your cash flow go down:
When you buy things for your business, your cash goes down. For example, if your gym spends $2,000 on cleaning supplies, you subtract that from your cash flow statement.
The last part of the cash flow statement is about getting loans, buying or selling things for your business, and other money-related actions.
When you buy or sell things for your business, it changes your cash flow. For example, let's say your gym did buy that treadmill.
- You spent $5,000 of cash out-of-pocket. This would be a subtraction from cashflow (like we learnt earlier)
- You also sold your old treadmill for $800. This would get added back into your cash flow statement.
When you get a loan or pay one back, it changes your cash flow. For example, if your gym gets a $5,000 loan for renovations and a $5,000 loan for that new treadmill, you add both of these to your cash flow statement.
Alternatively, If you pay back $2,500, you subtract it from your cash flow statement.
Now that you know your net earnings, and what cash REALLY left the bank, you can calculate whether or not you are cashflow positive. Let’s use our Gym for example.
Additions to Cash:
Net Earnings: $5,000
Depreciation: $2,000
Decrease in Accounts Receivable: $3,000
Increase in Accounts Payable: $1,000
Increase in Taxes Payable: $500
Loan Received: $10,000
Sale of Old Fitness Equipment: $800
Total Additions to Cash: $22,300
Subtractions from Cash:
Increases in Inventory: $2,000
Purchase of New Treadmill (in part): $5,000
Loan Payment: $2,500
Total Subtractions from Cash: $9,500
To calculate the net cash flow, subtract the total subtractions from cash from the total additions to cash:
Net Cash Flow = $22,300 - $9,500 = $12,800
Now as a business owner you may be thinking “Great I’ve got $12,800! Let me take out an extra $12,800 in salary"
Think again.
10,000 are loans that you are using with the hopes of increasing your cash flow in the long run (i.e. $5,000 treadmill and $5,000 of renovations should bring in $12,000 of memberships).
If you take it all out of the business, you’ll be 10,000 in the hole, with no new cash inflows and struggling to make your loan repayments.
BUT, if you spend it wisely, you could increase your cash flow by $12,000 a year.
See how one small decision on how to spend your money can completely make or break your business? That's exactly why cash flow is so important.
Your cashflow report can help you make important decisions for your business, such as:
There are a few things you need to look out for when reading your cashflow report.
If you're only cashflow positive because of a loan, that's not a good thing. You're basically borrowing money to keep your business afloat, and you'll have to pay it back eventually.
For example, you are cashflow positive with $5,000 in the bank, but you have a $10,000 loan out, that means your cashflow without the loan is -$5,000. Ideally you should think about getting this to a positive number.
It's also important to keep an eye on your cash inflows and outflows to make sure they're stable and predictable. If they're not, you might need to adjust your business strategy or find ways to increase consistent revenue.
For example your cashflow is $12,000 one month but $100 every other month (not totally uncommon for seasonal businesses), its probably a good idea to start thinking strategically about how to leverage your positive cashflow to create offers that are useful year round.