Lesson 10: Analyzing Cash Flow

1
Lesson 10 Analyzing Cash Flow Other Financial
Information
2
Amos Plumbing 1

• Amos Plumbing, a new company, was making a
  profit, but had insufficient cash flow to pay his
  payroll and other bills. How?
• The firm had to factor its accounts
• receivables (?) to pay bills.
• What does factoring do?
• Image-wise is it OK to do?

3
Amos Plumbing 2

• How is it possible for a company to be making a
  profit and yet not be able to pay its bills?
• A PL tells how profitable sales are. A Cash Flow
  tells how well you are collecting your bills and
  turning sales into cash.
• What options are open to Amos?

4
Amos Plumbing 3

• Take out a loan?
• Shut down the business?
• Demand that the contractor pay him when
• the work is completed?
• Sell his accounts receivables (factoring) for a
  discounted price?

5
New Business Dilemma Cash flow Squeeze

• 1. Purchases are often paid in cash (COD) as a
  new firm usually does not have the credit
  worthiness to purchase on credit.
• 2. Most sales are on credit.
• Often the credit accounts are not paid for 40 to
  45 days
• 2/10 net 30 What does this mean?
• Concept of free inventory
• Cash squeeze is exasperated when
• sales are growing. Why?

6
Measuring Cash FlowLook at the financial section
I handed out to you January 31.

• The best way to measure cash flow is to add all
  cash inflows (deposits) subtract all cash
  disbursements (checks written).
• Compare all initial cash on hand from investors
  or owners (equity), less the expenses for COGS as
  well as expenses such as payroll and taxes.

7
What is the BIG Question?

• You need to develop a set of tools to decide
  whether or not it is wise to pursue a potential
  business.
• Cash flow, balance sheet, income statement
• Economic Profile.
• Being able to forecast future cash flow is
  critical in determining the future viability of
  the small business.

8
Cash Flow

• Profits are great in the public owned arena, but
  they are not the focus of the small business
  owner.
• Your key is to take in on a monthly basis more
  cash than you pay out.

9
Why Is Cash So Important?

• Bills, salaries, etc are paid in cash.
• Miss a payroll, and employees will quit.
• Then you are out of business.
• Initially, most vendors are paid in cash - COD.
• The small firm will pay its debts in 30 days.
• Those purchasing products/services from the small
  firm though will have or take 40 or 45 days to
  pay their debts to you even if they agree to
  paying 2/10 net 30.
• They will late pay and take the discount.
• What can you do?

10
What is Float? - 1

• Float refers to the difference in time between
  when a check is deposited and cash is received or
  deducted from your account.
• Credit card float buy something (inventory)
  today and pay your card off completely in 25 days
  of pay it off over time.
• What is wrong with this way to play float?

11
What is Float? - 2

• As the small firm needs more supplies and inputs
  to make products, this cash squeeze become even
  more severe.
• This can be a large cause of failure for a small
  business.
• It is one of the big three reasons small firms
  fail.
• What can you do?

12
How can the Small Business budget for Float?

• By making cash flow projections that are
• ACTIVE
• ACCURATE
• and most importantly
• REALISTIC!!!

13
Cash Flow Statement

• Cash flow statements ARE NOT budgets.
• Cash flow statements are concerned only with
  three things
• 1. ACTUAL cash inflows
• 2. ACTUAL cash outflows
• 3. TIMING of cash movements.

14
An Example of the Difference Between Budgets and
Cash Flows

• Take a prepaid insurance for a year costing
  1,800 or 150 a month.
• A budget will account for 12 equal installments
  of 150.
• A cash flow statement will recognize a one-time
  only outflow of 1,800.

15
How To Develop an Accurate Initial Cash Flow
Projection

• Contact vendors/suppliers and ask about payment
  terms.
• What does this mean?
• Check with credit card companies and get
  information about when the accounts will be
  processed as well as what the interest
  percentages are.

16
What About When the Company is Up and Running?

• It is important to compare actual cash flow with
  the projected cash flow.
• This will illustrate the differences in estimated
  actual performance.
• Comparing today will help your firm make more
  realistic forecasts for the future.

17
Possible Information Gained from Cash Flow
Analysis

• 1. Why were sales receipts so far below
  expectations?
• 2. Why were traveling expenses so high?
• 3. Why were advertising revenues so small?
• A possible explanation for lack of sales?

18
Developing a Cash Flow Statement 1

• The cash flow statement of a small firm is
  different than that of a large firm
• Large firms have operating, investing, and
  financing sections to their Statement of Cash
  Flows
• The small business is only interested in the cash
  flows resulting from operations.
• Operations signifies all the cash flows in/out of
  the business.

19
Developing a Cash Flow Statement 2

• If used effectively. a cash flow statement will
  maintain an accurate representation of the
  overall cash position.
• An accurate, long-term history with your cash
  flow statement will assist the company with
  loans, credit lines, gathering equity capital,
  and valuation if the owner decides to sell the
  company.
• Why?

20
Developing a Cash Flow Statement 3

• A cash flow statement begins Cash Receipts
• then with expenses.
• Examples of possible expenses
• Salaries
• Cost of Goods Sold if selling a product
• Cost of Service if selling a service
• Taxes
• Office Supplies (often underestimated)
• Rent
• Salaries plus benefits
• It is important for you to account for EVERY
  expense.

21
Developing a Cash Flow Statement 4

• Begin accounting for Cash Disbursements, also
  called expenses, when through with all Cash
  Receipts.
• If possible, the company should separate its
  receipts into separate categories.
• It will help focus your business on which sectors
  of its receipts are important and will influence
  the operations of the business

22
Developing a Cash Flow Statement 5

• Multiple cash flow statements are useful if a
  firm is considering pursuing a new business idea.
• What is the likely scenario?
• What is the best case scenario?
• What is the worst case scenario?
• The scenarios will help identify the potential
  risk/reward associated with the new idea.

23
Pro Forma

• The term pro forma infers estimated.
• After a few years a small business will also
  likely want to develop a pro forma income
  statement (PL) and balance sheet in addition to
  the cash flow statement
• All 3 will give the small business owner a better
  picture of the future.

24
Balance Sheet

• A summary of assets and liabilities.
• Balance sheets are useful for the small firm in
  understanding what type of assets and liabilities
  can be expected.
• The pro forma balance sheet can help compare and
  understand how the assets are being used.

25
Types of Assets(Assets are used to generate
sales.)

• Current Assets
• Except for cash current assets can easily be
  converted to cash within a year such as accounts
  receivable, inventory, or notes receivable.
• Fixed Assets
• Assets that have a physical presence and include
  land, buildings, office equipment, machinery,
  and vehicles.

26
Types of Liabilities(Liabilities are incurred to
buy assets.)

• Current Liabilities
• Liabilities or debts that the small business must
  pay within one year.
• Examples are Accounts payable and Notes payable.
• Long-Term Liabilities
• Liabilities that are owed and due more than a
  year from the Balance Sheet date.
• Examples are mortgages payable.

27
Quick Notes About the Balance Sheet

• A balance sheet is a snapshot of a firm at a
• specific point of time.
• Owners equity assets liabilities.
• Owners equity everything you have less what
  you owe.
• Current assets minus current liabilities is the
  firms working capital ( owners equity).

28
Income Statement or PL

• Focus of the income statement (PL) is whether
  the firm made a profit or loss.
• This is NOT cash flow.
• Pro forma PLs project future income.
• Understanding future profit allows a firm to
  understand when it may breakeven.

29
Breakeven analysis

• Breakeven is the point where Total costs Total
  sales.
• ( in out.)
• Total costs Variable costs Fixed costs.
• Graph it.
• Understanding the break even point allows a new
  small firm to predict how much money it will need
  to survive.
• Shows the importance of minimizing fixed cost
  converting Fixed costs into Variable costs. Why
  do this?

30
Predicting Sales

• Be conservative in your projections.
• It is much better to underestimate and get a
  pleasant surprise than overestimate and get a
  nasty shock.
• Usually, you base future sales on past sales
  levels plus a small increase due to increased
  customer awareness of your firm.

31
Developing the PL Statement

• Sales minus COGS gives the firms gross profit
  margin.
• What are COGS?
• Subtract other expenses (i.e. salary, rent) to
  get the earnings before taxes taxable income.
• Taxes are then calculated and subtracted giving
  the firms (net after tax) profit.

32
Using the Breakeven Point to Plan a Targeted
Profit
33
Break-even Chart for Determining Target Return
Price and Break-even Volume
Total revenue
1200
Profit
Total Cost
1000
Break-even point
800
600
Dollars (in thousands)
Loss
400
Fixed cost
200
0
10
20
30
40
50
Sales volume in units (thousands)
34
Using The Breakeven Formula Rather Than The Chart

• Break Even Point Total Fixed Costs/Price
  Variable Cost.
• From the chart it appears that each unit sells
  for 20.
• Total Fixed Costs are 300,000.
• From the chart we can see that the Break Even
  Point is 800,000, so we can now calculate the
  Variable Cost.
• 800,000300,000/20 Variable Costs.
• Variable Cost 16.25 per unit (This means that
  profit per unit is 3.75).

35
Using Breakeven

• If it takes too many units of hours to reach B/E,
  you are in trouble.
• You must increase sales or reduce costs.
• Which do you have direct control over?
• It is more important to reduce fixed expenses
  than variable.
• Why?

36

• The end of lesson 10
• Analyzing Cash Flow.