Cash Flow Assessment
If you’re like most entrepreneurs, you might be frustrated at how little money you take home even though your business produces substantial revenue. Or you might be shocked at the end of the year when you’re hit with a huge tax bill, even though you have no money to pay it.
What you’re about to see may be contrary to what you believe. It will no doubt be contrary to what your accountant or current advisor tells you at the end of the year. But you’re no longer looking at things under the standard GAAP formula. You want to see your real cash flow, not the profit on paper or in your bank account.
Suppose you want to take control and manage your cash flow. In that case, you can do an assessment using your current or historical numbers to determine the difference between your actual cash-flow margin and what it could be using the cash-flow accounting method.
Here are the steps to that assessment:
Step one is to identify your company’s real revenue for the last 12 months. Use annual figures if you’ve been in business for over a year. You’ll need to complete this step monthly if you're a startup. Fill in your owner’s compensation, operating expenses, and profit. The total of the three categories should equal your total revenue.
Step two is to review the target percentages (of income). These may need to change based on your business, but this is what we recommend for most small business owners and/or pass-through entities. Also, if you’re not active in operating the business or do not take a salary, your operating expenses may be 60-80% because you’re going to pay someone, if not yourself, to manage the business.
Step three is to calculate your target amount (allocation). The target is your numbers if you implement the cash-flow accounting method. If you’re using a spreadsheet, it should calculate this number for you. If you’re using a print copy, you must multiply the actual revenue number by the target percentage (allocation).
Step four is to calculate the difference between your actual and the target allocation. To do this, you must subtract your actual numbers from the target numbers.
Finally, step five is to compare your actual and target numbers. Do you need to decrease your operating expenses? Do you need to adjust your compensation? Are you not saving enough? The increase/decrease calculation makes it easy to assess what you need to do.
Don't get stressed out if the assessment reveals that you must cut costs. There’s always a solution or strategy to make improvements or adjustments. You could trim costs by looking at your Profit and Loss statement line by line and marking each expense as:
Necessary, but need to consider lower or fixed costs
Necessary for producing income and cannot be changed
Unnecessary altogether and need to be canceled
Of course, there may be exceptions to the rule, and your business or industry may achieve more or less. You may need to begin this journey with slight adjustments to start. Then, as your business settles into the living margin formula, you will adjust your percentage gradually until you find your comfortable operating range.
And what if there is debt? If you currently have debt, the first thing to do is to stop adding to your debt immediately. Remember, you’re learning to operate well within your cash-flow margin. To pay off your existing debt, you may need to use a percentage of your profit account to pay towards your debt. Eventually, you’ll use your cash-flow margin to become your lender and to achieve accurate, lasting financial freedom.