Show Me The Money

How much cash does the firm have today?

Pretty easy to figure that out.

How much will we have next month?  The month after that?  And at the end of the year?

It matters.

If profit is the air we breathe, then cash is the lifeblood of the firm.

When the flow of its cash slows or stops, so does the firm.  Everything grinds to a halt.

If we don’t have adequate cash to stay ahead of our payroll and our accounts payable, we are in dangerous territory.  Unless we can get a timely infusion from clients who owe us money, we will begin to face some very sobering choices.

Bad Choices

Borrowing may seem like the obvious first resort, but without some confidence in an immediate payment coming our way, it’s really not a great choice.  Once we’ve borrowed, some or all of our free cash will be obligated toward the repayment of that debt.

Our other choices for managing a cash shortfall are just as unappealing, or worse.  Cutting costs can be very painful, and the savings can take time to materialize.

On a Need to Know Basis

We need to know if we’ll be depleting our cash before it actually happens.  If you’ve been reading my posts, you know that I’m a big proponent of predicting the future.

Forecasting, that is.  Eliminating uncertainty.

Can we reliably predict our cash flow?  You bet.

It’s actually quite simple to do.  And vital that we do it.

Comings and Goings

Everyone knows how to balance a checkbook.  Just record the money coming in, and the payments going out.  Simple arithmetic.

After a while, it becomes clear that we have fairly repetitious incoming and outgoing cash events every month.  Sort of predictable.

To predict cash flow, we simply run the firm’s checkbook forward.  We just need to know what’s going to come in and what’s going to go out.

We can then create a simple month-to-month cash flow model.

What’s Coming In?

To predict what’s going to come in, we simply look to our Aged Accounts Receivable (AR), and the rate at which we historically collect it.  There are formulas available for dissecting AR, but the firm’s recent history is a great indicator of how fast our balance is typically collected.  Take a look.

Say we typically collect one-third of our AR balance every month.  Then that’s our monthly incoming cash amount for our model.

For future months, we’ll want to add an average monthly billings amount to our AR before we calculate the predicted collection amount.  If not, our AR collection amount will be artificially low.

What’s Going Out?

Assuming we’ve also forecasted our Labor Costs (payroll) and our Indirect Expenses, we know what our outgoing expenses are going to be each month.  In addition to these monthly operating expenses, we’ll also need to include any capital expenditures or loan payments we intend to make, because they also come out of our cash.

So, cash in, cash out.  And on into future months.

Forewarned is Forearmed

In some future month, the model will likely predict that the firm’s wallet is going to be empty.

That’s normal.  (Unless it’s next month!)

As the firm wins more work, and adds it to its fee forecast, it pushes this outcome further into the future.

What’s important is that we know when that might happen, and can be prepared to do something about it.

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