How do we manage our resources? How do we track cash flow, profit and loss?
“Happiness is a positive cash flow.” Fred Adler – Venture capitalist
I may not be a millionaire but in many senses I have been rich. This is because for much of my life I have had the pleasure of not having to worry month by month about the balance in my current account. When billions of people are worrying about whether they will have a decent meal today or if they will have a roof over their head tonight then it is good to be thankful for such mercies. But I did not start out flush with cash and there have been times since where every pitch seems to be falling flat, work is short and I have had to dip into my reserves to keep afloat. At such times I have become very keenly interested in profit, loss and cash flow and therefore they should be things we have a handle on before we hit a challenge.
The day to day challenge of cash flow
Previously we looked at cost and resourcing in the context of a given task or project. When thinking in project terms the finances are focused on a finite amount that we are wanting to raise and control. When thinking about a business there may well be projects that we want to achieve; but the day-to-day of the business is defined by profit and loss and – perhaps even more importantly – by cash flow so I just want to highlight some crucial things to remember before we move on.
Cash flow is important as it determines the rate of return and affects liquidity. As Dragon’s Den star Peter Jones points out:
“There’s nothing more important than cash – cash flow issues are one of the biggest causes of company failures.”
Liquidity is especially important to the SME (small and medium sized enterprise), because you may well have invoices on the way but if they don’t arrive in time to pay off your debts then your company can go under, no matter how profitable you are on paper.
Cash flow and personal finance
The same goes for personal finances; after all a household is effectively a small sized business. You have certain a certain income and outgoings. Each month you need to make sure more comes in than goes out. If you achieve this then the amount left over, something you might choose to save or invest, could be considered profit. If you spend more than you earn then quickly you will get into debt. As debts spiral, because of interest rates it can become impossible to pay them off and then your household or business goes bust. It is very simple.
As an individual this could mean being declared bankrupt or as an organisation going into administration or liquidation. Either way it will be a huge hurdle in you fulfilling what you set out to achieve so it is best to reduce the risk of this happening by planning as carefully as possible and keeping on top of your accounts.
Keeping your accounts and balancing the books
At the most simple level you may just need a ledger or spreadsheet with three columns: one for money in, one for money out, and one to work out what’s left over. This gives you a snapshot of your finances at any one time. If you then produce a table predicting this information over a period of weeks or months in the future then you have the making of a cash flow forecast.
The issues of profit, loss and cash flow are perhaps most important when starting out in a new business. It can often take several years for a company to really become profitable and for finances to stabilise. It is therefore those first few years where the business is most vulnerable. Part of the business case and business plan at the beginning will be forecasting the finances over this critical time. If you want to attract finance or get a business loan then any investor will want to examine these figures. It is part of their risk management; they want to get their money back, with interest. You need to be profitable for them to be profitable. It can be tempting to be overly optimistic about what your finances will be in the beginning stages of a business. Therefore I recommend you produce several models for your cash flow: a best case, most likely case and worst-case scenario. Work out the most stripped down version of what you need to operate and the investment required, as well as your preferred initial equity.
I am not going to go into more detail on this here as it is outside the remit of this book but there are plenty of good resources on accounting that you can look at. Software packages such as Microsoft Excel (part of Microsoft Office) and Apple’s Numbers (part of the iWork package) provide spreadsheet templates for household and business budgets as well as cash flow forecasts. I have also suggested some useful links below where you can get more information.
 Quoted in the Telegraph, 24 Sep 2009