Cash Flow Planning

Financial planning for erratic incomes is important for almost any business, but for small business, it can be vital. Also, cash flow planning has become increasingly important to a growing number of working professionals like freelancers, consultants, small business owners, salespeople and executives who depend heavily on bonuses. Yet, budgeting cash flow is perhaps the most under utilized planning tool used by small business and individuals seeking to fix financial problems.

The U.S. Commerce Department now credits small business for most of the employment growth over the last two decades, so we should understand the skills these new entrepreneurs possess and where they are coming from. America has increasingly opened her markets to world trade over the past two decades, and the predictable downsizing by major corporations was triggered in large part by a significant production shift to overseas markets. This resulted in many capable and trained people looking for new ways of making a living. In the beginning, there were only a few, but their successes stimulated even more into the world of small business. While most new entrepreneurs understood the need for working capital, often taking it from savings or even credit cards, many didn't know that specialized accounting and financial knowledge was needed to manage their new enterprise.

For new entrepreneurs, erratic income is one of the most frustrating problems faced by business as they first start out, made even more difficult in Southwest Florida as seasonal residents continue to be a large part of our community.

Unfortunately, many professionals and business owners live on Maalox during the summers, long after the early years when they should have known to be prepared. Others plan.

Managing your cash needs begins with a budget based on your expected cash flow over a minimum period of twelve months, continually adding a new month as you move forward into the next. The first thing you should do is to estimate your income and divide it into monthly amounts depending on your unique business cycle. This may change over time as your business grows, for example you might have experienced a clearly defined cycle in the early years, but now the summer might be almost as busy, with peaks of activity in late spring or early fall. Whatever it is, you need to project your income into monthly amounts and total them for the year.

Look next at the minimum cost of providing that service, cost of goods that you will sell, or cost of services you will provide, and subtract these projections monthly from your estimated income. These expenses should be variable (they depend on the level of predicted sales activity), and necessary. Next you should deduct your fixed expenses that are paid monthly, like rent, leased equipment, electricity and telephone, then add periodic expenses like insurance, real-estate taxes, accounting and legal, into the appropriate month. Finally, you should examine your budget to see if discretionary increases should be made to advertising, marketing or other expenses. The bottom line is important as it demonstrates the dynamics of your business over the next year. The annual total indicates whether you should even be in business or not -- or, if it's your personal budget, whether you need to make lifestyle changes.

The final step is to calculate the cash needed to fund your operations over the next year. Add your monthly cash surplus or subtract your monthly deficit from your opening bank balance, and continue this procedure through the remaining twelve months. This will tell you how much you will need in the bank at any period in time. All of a sudden, that larger-than-normal bank balance in the good times is no longer a surplus -- it's the minimum amount you need to fund your operations or lifestyle over the next twelve months.

OK, now you know the large cash position you have in your account is not your bonus. It's the minimum amount you need to survive. It's like having nothing in the bank, because it's already budgeted to be spent. So what do you do with all that money? How should you invest it? Well that answer depends on how much it is, how long before it's needed, and how much of a permanent reserve you wish to keep. Usually the answer is to keep your immediate needs in a liquid bank account or money market account. Longer-term money might be placed in a short-term investment grade bond fund, which usually earns more than money market funds (pick bond funds with no commission charges and low expense ratios).

Cash flow planning may seem like rather simple advice. However, it's work that most people fail to do. A recent survey conducted by the Consumer Federation of America and NationsBank found that in households with incomes of less than $100,000, the overwhelming majority reported saving and investing twice as much when they had a financial plan than when they didn't. In many cases, planning is what makes the difference between success and reaching for the Maalox bottle every month. Enjoy running your business, rather than letting it run you.

John Kingston, CFP, is a partner in the Registered Investment Advisory firm of Investment Insight, Inc., offering a full range of money management and financial planning services with a fee-based/no commission compensation structure. He's the author of a fast-moving novel of foreign intrigue entitled The Level Playing Field.