Cash Flow Planning for Solo Professionals
Cash flow planning is an important facet of financial planning that is often ignored by solo professionals. "What's the point?" they might say. "I only have to pay myself." As you can see in this blog post, cash flow planning matters for all kinds of businesses, whether you're a sole proprietor or part of a larger company.
When I practice complex tax planning strategies or manage investments for my clients, it's easy to overlook the small things that can make a big difference in the operation of my business.
In most people's minds, cash is nice but not necessary. If a few million dollars in capital were to disappear from an individual bank account, the world would likely end tomorrow (well, at least until the next Krebs article appears). That kind of loss typically doesn't happen to businesses. And yet many small business owners treat cash flow planning as one more tedious chore that has to be done every year - if at all.
I'm here to tell you that you're wrong about cash flow planning.
If you're a sole proprietor or an S-corporation, you should be tracking cash flow all the time. I say should because I know many great guys and gals who run their business debt-free. These individuals are awesome, but they have one big problem: They don't have enough money coming in to cover their expenses. Why? Because they aren't keeping track of the money coming into their business and the money going out of it.
Cash flow matters even if your only source of income is a single client or one sale a month. Even if you're the most gifted accountant ever, if you don't know how much cash comes in and goes out of your business, you could be forced to downsize or even close your doors.
Put simply, cash flow is the lifeblood of a small business. If you get it right, you'll do great things with your money and your clients will benefit too. If you get it wrong, though, nothing less than failure awaits.
What is Cash Flow?
Cash flow is the net amount of money that comes into or goes out of a business during any given period - usually a month or a year. A business can have positive cash flow or negative cash flow.
Net cash flow is the difference between revenues and expenses over a given period of time. To calculate net cash flow, you start with your revenues (total revenues minus actual expenses) and deduct your expenses (total expenses minus actual revenues). What's left is your net profit.
Cash flow planning is the process of identifying and maximizing cash inflows and minimizing cash outflows. Your main objective should be to ensure that you have enough money coming into your business to cover its costs and still have some left over for profit. If you can achieve this goal, you'll be able to cover unexpected expenses, pay yourself a salary, or reinvest in your business.
Twelve Tips for Improving Cash Flow Planning
1. Realize that everybody needs cash flow planning. Sometimes we get so caught up in the numbers that we forget about the big picture. We may think that we're only dealing with dollars and cents, but that's not really the case. If you can't grow your revenues, you won't be able to grow your business.
2. Get used to the idea of planning for expenses ahead of time. Identifying expenses before you have an actual need for them will make it much easier to plan for them in advance (see tip #4).
3. Create an easy-to-use cash flow reporting system through a computer spreadsheet or desktop application. I like Excel because it can help me find patterns and trends in my numbers without having to do too much math (see tip #6).
4. Start by planning for expenses before you even know what expenses you have. If you have a general idea of your operating expenses, you'll be ready to take on specific ones when they arise.
5. Estimate your cash flow using the same type of accounting system that your business uses to track its revenues and expenses. If someone else is responsible for tracking everything, ask them to send you an estimate at least once per month.
6. When cash flow falls short of expectations, don't look for someone else to blame. Always remember that you're the one in charge and failure belongs to no one but yourself (see tip #1).
7. To figure out what your cash flow projections could be with improved profitability, talk to your vendors, customers and other business partners. What are you paying now? How much do they expect to pay in the future?
8. Make sure to adjust all of your cash flow assumptions based on similar businesses that you know well. For example, if you're applying a 5% discount rate to your revenues and expenses, I wouldn't recommend applying the same rate to a different company's revenues and expenses (see tip #8).
9. It's an easy mistake for a business owner to rely too heavily on his or her own experience when forecasting future cash flows (see tip #7). Always ask for another estimate from an independent source.
10. The level of detail in your cash flow planning will depend on your business's stage of development. If you're just starting out, you can use the cash flow reporting system that you're using for the first year of your business or a similar system that is easy to understand. As you grow, you'll need to become more sophisticated in your calculations and projections.
11. Your projected expense numbers must be realistic and achievable by the time they get through your financial planning process (see tip #6). If no one else knows what it's costing you now to do business, don't tell them until after they've signed on with you (see tip #3).
12. Cash flow planning isn't about planning for the next six months. It's about pre-planning for the next year (see tip #5).
If perfect is the enemy of good, then cash flow is worth having more of. The more accurate you can be in your cash flow forecasting, the less risk you'll be taking when it comes to making decisions. Cash flow is often just a number, but it's also a matter of life and death for many small business owners. If you want to be able to eat (and grow), there's no way around it: You need to know how much comes in and how much goes out.
Conclusion
Cash flow planning should be one of your most important tasks as a small business owner. Put the same care you would use to plan out your marketing strategy into writing your cash flow. You'll make important decisions based on its output, so don't make any rash decisions without first checking it out.
The book is available for free on every page of this website and in the Amazon search bar at bottom right, just type "cashflowplanning" and press enter.
I want to close with a story about two companies that had nothing but great cash flow: Research In Motion (the makers of the Blackberry) and Taco Bell (the king of the quick-service restaurant business).