What Is The Right Cash Flow Formula For Your Business?

I think we would all agree that Cash Flow is one, if not the most important element of your business operations. Too much and you are not maximizing your return on investment and too little may turn into that dreaded word – bankruptcy. So what is the right formula? Read More.

I have written about cash flow on a number of occasions, but reading more and more dealer financial statements compels me to revisit this subject. The best question I can ask is how many of you actually prepare a cash flow projection? There is no shame in saying you don't, because it is a complex set of numbers that requires planning, forecasting, economic analysis, and expense control. Who has the time?

The problem is by not preparing a cash flow projection you could be courting disaster. I have been on the other end of far too many phone calls from the finance company or field auditors that say we have a problem. There are 10 units sold and the dealer can only payout 5. I don't need to tell you what happens after that.

Even worse, it is pay day and you're not sure you can make payroll. These are harsh realities in business that none of us want to even consider, but unfortunately this happens all too often. The solution is to prepare a business plan that you can extract a cash flow from, which will establish your cash requirements for the year.

The rule of thumb when establishing your requirements is you should have enough cash flow to cover your overhead for two months. In other words, if you were to add up your monthly expenses including salaries you should have two months of this value in the bank. This does not include your inventory purchases such as parts, accessories and units. Much of this is financed or on extended terms of payment so it should not be factored into the calculation. Simply put, if your overhead equals $35,000 for a month, then you should have $70,000 in the bank at any given time.

The logic behind this calculation is you will experience peaks and valleys in sales volume during your fiscal year. During those slow periods when expenses are out pacing sales you need to have enough cash flow to cover the difference.

If your projection indicates a shortage during certain months of the year, but your annual business plan projects a reasonable profit, then it is time to visit your bank for an operating line of credit or if you have one, get an increase. Banks will respect the fact that you have built a plan and can substantiate your projections. If they can see that the credit line will revolve over your fiscal year they will be much more receptive to approving an operating line of credit.

If you are seeking a credit line to offset increased debt such as a net loss from the last fiscal year, you will have a more difficult time getting this approved. Increasing your credit line to offset debt is like a dark hole that just gets deeper and deeper. In theory, losses should be covered, if necessary, by additional investment by the owners. Acquiring a credit line for debt is like going to a loan shark to cover off your losses at the track. It rarely works!

The flip side of this coin is the importance to retaining profits in the company when you have a good year. We all want to minimize the amount of corporate tax we have to pay, but it is equally important to retain as much profit as required to minimize your cash flow needs.

As I mentioned at the outset, your objective is to maximize your return on investment. Consequently, you need to know what your cash flow requirements will be for the next year. In my opinion this can only be achieved through the building of a business plan and cash flow projection.

If you are not comfortable with building your own plan, contract someone to help you. I know it is hard to part with your hard earned money on an intangible expense like business plans and cash flows, but for every $1.00 you spend you will have the potential to earn back $10.00.

Knowledge is power so if you need help, contact me for a free consultation.

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