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3 Must-Knows and 3 Tips in Understanding Your Cash-Flow

We are in the midst of a global liquidity shock.

What is that? It goes like this. Business A is not getting paid. To preserve cash they stop paying their payables.

Business B is Business A’s supplier. Business A’s account payable is Business B’s “accounts receivable”.

Business B, in turn, tells its suppliers that “no one is paying us!”. So, we cannot pay you. Ouch.

Business C (customer of Business B) says the same thing to its suppliers…

…and so on, and so on, and so on…

It is a Global Liquidity Shock.

To manage your cash-flow you must know three things it is made up of.

First Thing – Cash-Flow From Operations

You sell stuff. You have expenses. The difference is your net profit. So far so obvious…

Imagine you sold only for cash. You paid for things only with cash. Your net profit would equal your operational cash-flow.

That is not what happens though is it?

People do not all pay cash. You do not pay all expenses with cash.

Accounts receivable will become cash when collected. Inventory becomes cash when sold.

Accounts payable and other things you owe will use cash later on.

The first section of your Cash-Flow statement is called Operational Cash-Flow.

You begin with “Net Profit”.

Did “accounts receivable” go up from last month? Subtract the difference from net profit. You have not received that money yet.

Did “inventory” go down from last month? Add the difference to your net profit. You sold stuff.

Have your accounts payable gone up? You have not paid all your bills. Add the difference to your net profit.

Rule # 1 : every current asset that goes up you subtract that from your net profit. Every current asset that went down you add that to your net profit.

Rule # 2 : every current liability that went up you add that to net profit. Every current liability that went down you subtract that from net profit.

Rule 2 is the exact opposite of Rule 1.

Here is a sample Operational Cash-Flow:

 

Net profit $6,000
Accounts receivable went up (600)*
Inventory went down   900*
Accounts payable went up 3,000**
Operational cash-flow $9,300
   

*see Rule #1

**see Rule #2

Part 2 – Investing Activities

There are other things that affect cash-flow that are long-term. Buying fixed assets is one example.

You take the Operational Cash-Flow as above. And deduct the investment in long-term things like fixed assets.

It looks like this:

Operational cash-flow $9,300
Purchase of equipment (6,000)
Loaned money to another company (3,000)
Cash-flow before financing activities $300

 

Part 3 – Financing Activities

Now, you take your Cash-Flow before Financing activities  as above. You add or subtract things like long-term loans and shareholder dividends.

These include long-term loans and dividend payments to shareholders.

You start with your cash-flow before financing activities as above:

Cash-flow before financing activities $300
Long-term loan from bank* 6,000
Dividends to shareholder (2,100)
Cash-flow before financing activities $4,200

*you financed the equipment above assets

3 Cash-Flow Tips

  1. Push hard (with kindness) on accounts receivable collections. Use software to chase outstanding invoices. Make calls. Document everything.
  2. Extend payments on accounts payable. Work out payment terms with your suppliers.
  3. Finance equipment with long-term loans.

Thanks for reading…(if you need help, private message me)