Managing Your Cash Flows: Part Three
About the Author:
Paul Wilton (editor)
CA with degrees in commerce, accounting and information technology. Paul worked overseas in the “Big 4” accounting firms and served as a director at Audit New Zealand before setting up his own consultancy. Author of A-Z of New Zealand Business Law, Paul has over 20 years of experience as a business owner and consultant. He joined FBA in 2004 and is totally committed to providing excellence in quality and value to our subscribers.
This is the final of a 3 part series on cash flow management. In our first issue we introduced the concepts of cash management, looked at external sources of funding (equity financing versus debt, grants, investors, factoring and overdrafts) and internal sources of funding (fixed assets, raw materials, saleable stock, and debtors). Our next issue examined debtors, creditors, increasing sales, saving on costs and how to get quick cash when you are in a sticky situation.
We now take a look at:
how to budget and forecast
how to manage cash reserves
how to manage petty cash
Budgeting & Forecasting
Budgeting and forecasting (simply referred to as budgeting) is like reading the map before you head off into the unknown. It provides you with direction and keeps you on track. This is one of the most overlooked management undertakings in smaller businesses and it is commonly the reason small businesses get into strife. Larger businesses generally have internal resources (accountant/s) to cope with budgeting and forecasting demands.
A budget is simply an estimate of revenue and expenditure over time.
Step-by-step Process of Forecasting
The simplest means to set up a budget is firstly to draw up your accounts for the past year on a month by month basis depicting sales, sales related (direct) costs, indirect costs (overheads), profit, taxes and net profit. This is simply a profit loss by month.
Insert blank columns beside each month for the coming year
Estimate the likely sales given market trends and fluctuations, consideration of your marketing and sales plans, and other factors which may affect sales such as staff changes, extra staff or new products. Be careful not to be over optimistic. Be realistic!
Do the same with all your expense items.
Now delete the columns for the previous year and voila! You have a forecast of expenditure for the next year. Note that this is not a forecast of monetary movement ( cash flow) but of accrued profit/loss for each month
Now you can translate the information into a cash flow forecast by adding lines for GST in the income and expenditure sides and writing in the calculated values. Also write in all other expenses that you are likely to experience, i.e. separate PAYE out from gross wages, apply FBT for each month where pertinent
At this stage all costs are aligned with the month they were accrued. You now need to “shift” the income and expenses across to allow for time lapses to represent cash flow. If you are a retail business the cash from sales would simply remain in the same month. However, credit sales and purchases would go into the following month, as would overhead expenses, as a reflection of payment on the 20th of the month following. Undertake a similar exercise for GST, FBT and other expense items.
The above will show where you have projected deficits in cash and therefore indicate the cash reserves required to trade through without borrowing money or without exceeding your overdraft. Start up businesses are particularly susceptible because in the second year they have to pay provisional tax as well as terminal tax – double the tax in one year as the first year of trading is effectively a tax holiday.
Sample cash flow Analysis
Below is a simple forecast for a manufacturing company that makes an annual budgeted profit of $260,000. GST has been calculated by month using the gross sales figure (as GST is paid on sales and collected on direct costs) and GST is represented also for overheads on all items below except wages and interest.
We can now transpose the above budgetary forecast into a cash flow analysis by shifting the income and expenditure lines accordingly. Note that for this example GST is paid 2 monthly and income is on average 2 months after month of sales and expenses are 1 month after date of purchase. Hence we get the following:
The important thing to note here is that the business actually has only $2,000 in the bank in August despite projecting substantial profits (first table) for each month! The projected profit for June was $22,000 whereas the cash flow for June was -$19,000, all due to timing of cash in and out. This demonstrates the need to budget very carefully in order to maintain business liquidity irrespective of projected profits.
How to Manage Cash Reserves
The example also demonstrated that, although there is $27,000 in the bank in May, this cash reserve is expended over the next few months to maintain cash flows. Hence the need to maintain accounts for managing the spare cash before it is required. Most businesses retain call accounts or other higher interest paying accounts which provide for ready cash. However, if budgeting effectively then you can plan how much to invest for say 60 or 90 day term rates until the cash is required again.
You should always keep enough cash on hand to cover expenses and as an added cushion for security. However, it is unwise to keep more money on hand than is necessary. Excess cash should be invested in an accessible, interest-bearing, low-risk account, such as a savings account, short-term certificate of deposit or Treasury bill. Keeping excess cash on hand limits both your growth and the return on your investment. Also, transfer between accounts where possible to avoid having excessive cash in one account and an overdraft in another.
How to Manage Petty Cash
We refer you to the FBA Doing Business in New Zealand which has a comprehensive coverage on how to manage petty cash. This is briefly summarised in the following paragraphs.
Petty cash is required to pay for day to day expenses such as tea, coffee, toiletries or other urgent small items that would be otherwise difficult to obtain through use of the cheque book. You don’t want to keep too much cash on hand at the business premises as this may well present a security risk.
Method 1: Use of Takings
This method of using petty cash is common in businesses that have a cash register and receive cash as part of the daily transactions. Milk or a newspaper can simply be bought from the money in the till. Accounting for petty cash should be done using a dedicated petty cash book and at the end of each month the figures can be entered into the journals. The total bankings for the month plus petty cash out should equal takings over the counter.
Method 2: Petty Cash Account
This is common to the way many businesses operate. When the petty cash box is set up money is withdrawn from the bank to the value of $200.00. When the petty cash gets low a further amount is withdrawn to “top up” the petty cash box to the required $200.00. The transactions are recorded in a dedicated petty cash book showing all deposits into the petty cash and all withdrawals from petty cash book. The petty cash book does not need to be fancy. The following is an example of a good petty cash book:
Reconciling the Petty Cash Book
The next trick is to reconcile the petty cash book. If you have a manual journal system then your accountant will sort this out at the end of the year without any fuss OR simply have an entry item in the books for sundries.
If you have a computerised system then you may want to allocate the cheque for petty cash to a current asset item called petty cash. At the end of each month you will need to make an entry in your journals to account for the petty cash spent. For the example above this should look like:
This in effect reverses your cheque allocated to petty cash and allocates the items to the accounts they actually belong to. Better still, we recommend that you group items, e.g.
You may check your financial information monthly but are you doing enough? Do you create a cash flow chart? And have you established the cash flow goals for your business, both long and short term?