Picture this - you finally win a federal contract only to realize you now need to scramble to figure out how to finance your new government contract. Did you realize it could be up to 60 - 90 days from when you begin performance until when you see cash flow back to your business? How will you pay your employees? How will you make payments on the equipment you’ve leased? What kind of terms and rates will you get on a term loan or line of credit when you’re scrambling at the last minute?
The importance of cash flow analysis
Understanding the importance of cash flows in a business allows you to optimize your operations and sleep better at night. It helps you forecast where you may have cash shortfalls and then plan ahead. Strategically utilizing term loans, line of credit, or contract mobilization funding can save you from falling victim to last minute predatory loans with outrageous terms and conditions.
Running short of cash flow can be the stuff of nightmares for a small business owner. For most, you opened your business because you were an expert in your field. You were an IT pro, so you opened a managed services firm. You were an experienced engineer, so you set up your own engineering firm. Few entrepreneurs opened their own business to manage finances, unless of course you are a financial firm. Yet, most successful business owners have realized that in order to remain competitive, in addition to understanding their trade they must also understand how their business operates.
How do you do this without a full-time bookkeeper?
Well sit down and strap in, we’re about to go on a wild ride of financial ratios and analysis! These are only some of the many different methods that give you varying perspectives of your working capital at a high level for the upcoming year. For a more detailed analysis you may want to consider a consultation with a CPA or other financial professional.
Keep an eye on accounts receivable
One action step you can do today and on an ongoing basis is to keep an eye on your accounts receivable aging report. How long is it taking you to collect unpaid customer invoices? As your accounts receivables age over longer periods, you leave your business with less of an ability to pay liabilities. Setting up a financial dashboard with statement of cash flows reports is a great best practice that can help you identify trends before they become problematic. You’ll be able to tap directly into the financial health of your business and proactively. A dashboard that shows you your current and quick ratio, accounts receivable and accounts payable turnover ratios can give you a better sense of how optimally your business is operating from a financial perspective. This information may signal you that updates to your internal policies could help improve your bottom line, or help you anticipate future cash flow needs.
Make your cash flow data work for you
For this next method, to start with, you want to be working with accurate numbers from the previous year and forecast for the upcoming year. The quality of the information that comes out of this analysis will only be as good as the quality of the data that has gone in. Or in simpler terms: garbage in - garbage out.
Now that you have your books ready to go, you’ll want to start by looking at your ending year’s numbers. By breaking down your annual cash expenditures into daily cash expenditures, and then multiplying that by your cash cycle, you can see what your annual working capital needs were for the ending year. If you turn this into a percentage of previous year’s sales, and then multiply that percentage by next year’s projections, you now have a projection of your upcoming year’s working capital needs.
These methods will empower you with a better understanding of how the financial side of your business operates. With this better understanding you can make more strategic decisions so that you are prepared with the capital you need, when you need it.
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