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In the world of small business, cash is everything. You don’t yet have the war chest necessary to survive dry periods and the way that you handle the limited resources at your disposal is crucially important. Too often, small businesses get themselves into trouble because the metrics that they chase are all theoretical, and they underestimate the impact that a cash flow crunch can have on their plans. In fact, 82% of the small businesses that fail do so because of cash flow problems.
To avoid this and to plot a robust strategy going forward, you have to understand how cash flows in and out of your organization—because that is your lifeblood. In this article, we’re going to discuss how using a cash flow calculator can transform your decision-making and therefore your results.
Calculating your cash flow is slightly different from calculating your profit because we only want to look at transactions that result in cash inflows or outflows. This helps us isolate the cash movements within your business so you can go about making the appropriate adjustments to improve your cash position.
For illustration purposes, let’s imagine that your financials look like this:
|Statement of Profit and Loss|
|Cost of Sales||($3,765)|
|Profit Before Tax||$7,157|
|Prior Month||Current Month||Next Month’s Projection|
|Other Non-current Assets||$24,358||$22,430||$23,113|
|Current Portion of Long-term Debt||$9,875||$9,540||$9,500|
|Non-current Portion of Long-term Debt||$30,450||$27,643||$26,450|
|Total Equity and Liabilities||168,763||$171,738||$175,293|
|Statement of Cash Flows|
|Current Month||Next Month’s Projection|
|Operating Cash Flows||$1,739||$2,560|
|Investing Cash Flows||$754||($1,002)|
|Financing Cash Flows||($478)||($234)|
|Total Cash Movement||$2,015||$1,324|
Using these numbers as an example, let’s look at three separate formulas that you can use to calculate different aspects of your cash flow.
The free cash flow formula aims to answer the following question: How much money do I have to spend at my discretion?
For example, perhaps you’re trying to decide whether it would be a good decision to hire a new employee—but you want to make sure that you can safely cover their salary without putting the business at risk. You want to calculate the free cash flow remaining after you’ve serviced all the other costs of running your business.
You can see that we need to calculate two components first before we can use this formula: our change in working capital and our capital expenditure.
Our net working capital figure is calculated by subtracting our current liabilities from our current assets. So, for our current month this would be ($27,640 + $10,435 + $10,483) – ($11,750 + $9,540 + $5,234). This gives us a net movement of $22,034 for the current month. Then we must calculate the change so we need to subtract from this our working capital movement from the prior month. Following the same process, the prior month would look like this: ($24,500 +$12,540 + $3,665) – ($14,790 + $9,875 + $4,573) = $11,467.
The change in working capital therefore would be $22,034 – $11,467 = $10,567.
Our capital expenditure is calculated by looking at the change in non-current assets month on month. In this example it would be ($100,750 + $22,430) – ($103,700 + $24,358) = -$4,878
Now that have all our components, we can calculate our free cash flow as follows:
This calculation helps you to understand the financial health of your company at a specific moment in time and that is a key indicator of what your spending power is as an organization. With this information, you can then properly assess new investment opportunities, product development, hiring, and more. With a free cash flow figure of $928, we probably don’t have the cash for significant investment at this stage and we would need to grow the business more before making those moves.
Your operating cash flow looks at the day-to-day movements in your business and whether your operations are generating enough cash to service your short-term obligations.
The formula looks like this:
Before we start here, we’ll need to calculate our operating income which is done by subtracting our operating expenses, depreciation, and amortization from our gross profit. In our example, this would be $10,795 – $2,031 – $975 – $632 = $7,157. We can now plug the other pieces into the formula as we have already calculated the change in working capital above.
Understanding your operating cash flow will help you adjust operational processes and other workflows to improve your cash generation capabilities. It’s a crucial part of the puzzle and something you should keep an eye on regularly.
So far we’ve only looked backward, but an important part of the long-term sustainability of your business is to look at your forecasted cash flows. This helps to anticipate potential problems and make optimizations to your business model that allow for a much smoother ride.
The formula looks like this:
In our example, the net cash movement seen on our cash flow statement summarizes our projected inflows and projected outflows. As a result, the calculation is relatively simple.
We can therefore expect to be in a strong cash position at the end of the month, and this forecasting helps us to evaluate whether more financing is needed, or whether we can afford to put some of that cash to work in growing and expanding our operations.
Once you have this cash flow information at your fingertips, you then need to be able to use it to take real practical actions that can push your business forward. This is a process of continuous iteration and it should become a natural part of your regular strategic operations.
Here are some core principles to keep in mind:
If you can get these core pillars right, you’ll find that your decision-making improves drastically. They are tried-and-tested best practices that once leveraged, can be transformative for your growth and long-term trajectory.
We highly recommend that you invest some time in understanding these concepts and using a cash flow calculator to explore how it might change the way that you think. Instead of getting carried away with profit calculations all the time, it’s worth returning to the heart of your business—which is the cash itself. It might just save your business.
Good luck, and we can’t wait to see what you build!
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