(If you like this article and wish to pass it along to someone else, please use our on-line form)

The essence of cash management

How to have the right amount of cash in your business at the right time

As a fourth generation owner, there were a couple of items I remember an advisor telling me. The first was to be sure to pay the IRS first. “Other people and businesses may sue you and stop shipping merchandise to you, but the IRS can take everything you own”, was the essence of what I was told.

The second was a statistic about business failure. Simply stated, most businesses that fail are actually profitable at the point the business closes. The business fails because it runs out of cash. In a word, the problem is, “cashflow”.

An accountant can give you an elaborate explanation of “free cashflow” and other accounting terms, but the essence is having enough cash in the checking account to pay the bills – equipment, inventory, payroll, operating expenses – when they are due.
When these items are not paid on time, the business experiences employees quitting, vendors charging sizable interest rates on outstanding balances (how about 18%?) and penalties.

I recently had the opportunity to look at the first six months of the income statement of a business. I don’t know what the penalty was for, but on the income statement was, “IRS penalty” in an amount equal to 14% of the profit for the first half of the year!

Worse yet, was the owner whose practice is to take all the invoices paid along with the register of cash receipts and put them into a box to be delivered to the accountant. With that information, the accountant created their state and federal tax returns for their multi-location business. There has never been an income statement or balance sheet created!

So these are hopefully a pair of extreme examples. Let’s get to what all businesses should be watching.

You are an inventory heavy business. Boats, trailers, accessories, parts; and like most every form of retail, most sales occur in a small portion of the year. Add to that the requirement of ordering and receiving merchandise for next season during the current season.

Inventory control decisions need to be made by the dealership with plenty of examination of how much sell-through has occurred and what has been the maintained margin. (Note that maintained gross margin is the actual margin after any discounting. The initial gross margin is the price you establish when the inventory first arrives.)

We have observed retailers who want to make sure they have plenty of inventory in every category throughout the season. While a noble concept, it likely means the dealership is going to have this year’s inventory marked down at a point where sales are diminishing and the next year’s inventory is arriving.

We taught a class to a group of buyers who liked the idea of always having plenty of inventory on hand. We changed a few minds when we used this calculator to show the initial gross margin of 30% had evaporated to a maintained gross margin of only 16% because of the amount of inventory on hand and the markdowns taken toward  the end of the season.

The tracking of sales and inventory on hand does not need to be a complex formula. It needs to be calculated according to categories however you decide to divide your business. We like to see categories having at least 2% of the gross sales and no more than 10%. While very simplistic, the Excel calculator that downloads from this page demonstrates the information needed; anticipates sales by month, inventory on hand, and anticipated maintained gross margin by month. Simple, but functional.

Another component of profitably managing the business comes with observing trends within your business and making decisions accordingly. We listened as a manufacturer’s sales manager told their sales team that the goal for the next season was a 10% increase in sales.

Unfortunately, the sales team understood that every category of products manufactured, and dealer was to increase orders by 10% over the previous year. This meant there would be categories in which dealers were buying more inventory in areas with a low sell-through, and areas where a 10% increase would not be sufficient for the next year.

This can also occur when you begin to plan for the coming year for both revenue and expenses. You may anticipate a 5% increase in sales. That may be the total for the year, but it will not be 5% for each month.

There is an opportunity to improve budgeting by taking a closer look at your past. An owner called early this year to share what was thought to be good news regarding net profit for 2022. This owner shared several years of financial statements. We used this calculator to produce a four-year comparison. While pleased with the dollar amount of net profit, looking at the maintained gross margin and each of the categories of operating expenses, the dollar amount of net profit would have been twice as much if the maintained gross margin percentage had been highest, and each category of operating expenses had at their lowest percentage of sales.

The previous sentence mentioned there would be more profit. It did not say there would be more cash. Every business owner learns at some point that profit and “cash on hand” are not interchangeable terms. When it comes to looking at your checking account balance at the end of the year and the amount of profit, there is very little connection in the two numbers. This is where that concern about profit and business failure begin to come together.

Your business as a whole also needs, (or can I say, “requires”) a budget. Creating the budget for your business is a simple process and you are the most qualified person to make the budget.

Let’s go back to that multi-year analysis calculator we shared earlier. Starting with each row of sales, maintained gross margins, and each row of operating expenses, do you see a trend? Do you expect that trend to continue? That information and thought can guide you to determining a number that is your goal/expectation for next year. When you complete that, the resulting net profit is your expectation for next year.

Now take that year-long projection and break it down into the twelve months of the year. In the same manner, look at the information for the previous month of January and perform the same calculation. Doing the same with each of the other eleven months, you are building a twelve-month budget for next year.

There is no software or outside individual that can do this job as well as you can! There is however, one big problem with the budget. It is not going to tell you if there will be enough cash on hand to make the budget work! This is where you put the budget to the test as you create a projectionary cashflow plan.

It is at this point that the format of your income statement comes into consideration. Within accounting, there are two formats for your income statement. One is “cash basis”; the other is “accrual basis”.

The cash basis income statement reports all of the income and the expenses in the month in which the money comes into your account or leaves your account. The format does make understanding your business a bit challenging. Follow this example.

A business has a property tax of $72,000 for a year. The bill comes from the state in September with a due date of April 1. However, the state allows a discount of ½ of 1% for each month the bill is paid earlier than April. If the business paid the property tax bill in September, they are entitled to a 3 ½% discount; that amounts to $2,520 in savings if you have the cash on hand to pay the bill in September.

However, our sample business, as does most every business, has high points and low points in cash that vary from year to year as to where they occur. In a three-year period, the business could pay the tax in September, pay no tax in the following calendar year and pay the tax in March and September the following year meaning in the third year they have paid $144,000 in taxes.

Putting the three years side by side, it is going to be difficult to see a pattern in the profit because the expenses were not paid in a similar pattern. The property tax is only one example with “cash basis” accounting.
The alternative format is called, “accrual basis” accounting. Using the same tax example, the income statement reports the tax bill as it occurs which is different from the way it is paid. The tax bill occurs $6,000 each month. In accrual basis accounting, the income statement reports the monthly $6,000.

This same format can be applied to income. A customer has your dealership performing a sizable update and repair on their boat. This work is going to take many months. Perhaps you get a down payment; partial payment several months later; and the balance when the project is completed. The work on the boat is performed at an even pace. The income timing does not match the expense outflow timing. These fluctuations cause a challenge in monitoring your profit and cash position.

This is where you get to make the decision as to which format – cash basis or accrual basis – is used in your business. Neither causes your business to make more or less profit. We think the decision should be based on which format provides you the most information in making decisions.

The link we provide goes to two Excel charts that are simplistic yet explain the format of charting your cashflow expectations for twelve months. You will also want to download the PDF which gives explanation of the files.

Having a projectionary cashflow calculator is not a guarantee that a cash shortage is not going to occur in your dealership. However, used properly, and with the information and tools we have already introduced, you can accurately project your cash needs and cash position for each of the next twelve months.

The numbers in each of the Excel files are there only to provide an example. However, in both the cash basis and the accrual basis examples, there is a very valid example shown in the first three months.

The business starts the year with what would likely be for this small business, enough cash. During the month of January, the business spends more than it takes in. This situation continues into the month of February to the point that the business shows a negative cash position at the end of the month. This cash position does not improve with March.

If the business owner were without the benefit of the projectionary cashflow chart, this would be an ugly situation for the business. However, in having the projectionary cashflow chart, this business owner would see this problem a year before it happens. Changes could be made and if needed, a line of credit could be applied.

Having a business is not without its challenges. However, monitoring and managing cash and cashflow does not have to be one of those challenges.

If you would like to send this article to someone you know, please use this form to forward this page:

Your Name:	E-Mail:
Friend's Name:	E-Mail:
	Security Code:

This article is copyrighted by Tom Shay and Profits Plus Solutions, who can be reached at: PO Box 128, Dardanelle, AR. 72834. Phone 727-823-7205. It may be printed for an individual to read, but not duplicated or distributed without expressed written consent of the copyright owner.