Cashflow part 2: the control

2008-07-07 00:00

A couple of weeks back, I looked at the principle of cashflow and how even when you are making a profit you can still experience cash shortfalls.

This week, I want to outline the basic methods for producing a cashflow control and highlight the fundamental differences between a “cashflow report” and your monthly management or profit and loss accounts.

There are times when a specific need for funding or cash in the business will arise:

• In a start-up business needing to equip its offices, factory and/or shop, buy in stock and to carry the business through to when it has established a steady income level;

• The business may wish to expand its operations, range or just renew its machinery and equipment.

Most SMEs will turn to their banks for funding these activities and the bank manager will want to see audited and management accounts (profit record) and also your “cashflow forecast”.

They want to see your business will be able to generate sufficient surplus cash (not profit) to pay monthly interest on the loan and repay the capital sum of that loan.

The best time frame for the cashflow forecast will be monthly and usually needs to forecast for two to three years. The best format for your cashflow forecast starts with incomes (cash in) at the top and the expenditures (cash out) underneath.

A cashflow report will also need to include an opening cash balance at the beginning of the month at the very top and a closing (end of month) cash balance at the bottom.

This closing balance for the month will be the sum of opening balance plus incomes (cash in) for the month minus expenditures (cash out) for the month.

Although the cashflow layout follows that of your monthly trading accounts, the rand sum you include will often be different and some items, which are specific to each report, will not be included in both.

Some items that appear in your management accounts will not apply to your cashflow because they do not involve cash. Equally, additional “cash items” will be included in that cashflow, which do not directly affect your trading profit.

The three major differences between the P&L and the cashflow reports to take into account in producing your cashflow forecast are:

1. Trading accounts report everything excluding VAT. Business only “collects and repatriates” VAT for the government.

VAT has nothing to do with making a profit. However, cashflow must include VAT wherever it applies because it is cash that both comes in and goes out of our business.

Most businesses will be registered for VAT and will return that VAT based on invoice (not cash transactions) every third month for the two previous months’ invoices.

2. Trading accounts report both sales and expenditure at the time of use or activity. If we used the stock and generated the sale in March, it is reported in the March accounts.

The cashflow reports at the time of receipt or payment. In other words, only in the month the customer pays us or we pay our supplier is that amount included.

With credit terms negotiated for up to 90 days this could mean sales income may only come in as “cash” some three months later — possibly after the VAT on that sale has been paid to SARS.

3. There are costs such as depreciation that are set off against profit but have no relationship to cashflow. You may buy a company car today for example, paying 50% now and the balance, monthly, over the coming three years.

That is how the car purchase will be reported for in the cashflow.

But, in the trading accounts, the full value of the car will be put into the balance sheet as an asset and only say 20% of that amount put into the trading account each year as depreciation.

In a similar way as this, we shall touch on the balance sheet and its implications against both cash and profits next week.

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