Managing Your Cash Flow

Ken Cone, CPAAugust 17, 2010408-859-3109

ken@order-from-chaos.com

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Learn How to Make Your Money Work for You

• This program is intended for future entrepreneurs. An entrepreneur is a person who organizes and manages any enterprise, esp. a business, usually with considerable initiative and risk; Random House.

• My goal for today is to help you learn that understanding the accounting function empowers you. Through this empowerment, you can attain your purposes.

• Small businesses have three main activities:1. Production: what the Art Institute is training you to do2. Marketing: driving business in the door3. Accounting: managing the data and facility that your activities require and produce.

(Facility is something that permits the easier performance of an action, course of conduct, etc. Random House)

• Most of you who do go into business will do so in the profession that you are now being trained for. This means that you will be very good at production. However, you will need training in running the business in such a way that marketing and accounting are helping you to be profitable.

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The Flows of Activity Through an Organization

• Our bodies require food, air, and water to live. Those substances are systematically processed by our bodies. Businesses also operate on a system of flows that can be understood.

1. Communication: • Someone comes through the front door, calls into your facility,

or emails you, etc.• That person is routed to the proper place, by a receptionist,

host, or customer service, for example:• Prospects (a prospect is something in view as a source of profit; Random

House.) In our case, prospects refer to potential customers.• Customers• Vendors (a person or agency that sells, Random House.)• Others (Such as legal, police, people asking for the restroom, etc.)

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2. Sales:• Prospects are routed to a sales person to get

placed in the correct part of production. At a restaurant this would be the waiter.

3. Treasury:• Before services can be performed, funds

must be available to finance operations. In industry this is done with capital from equity (what the owner invests) or borrowed funds. In a perfect world, the customer pays before services are rendered.

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• Treasury accounts for:– Collecting on sales– Paying bills– Accounting for assets and liabilities

• Assets are resources that are or should be available to the business for use in creating profits and other activities. Cash and inventory are assets. Some assets are treated as balance sheet items while others are expended directly to profit and loss. For example, a stapler might last for five years. However, its value is too small to bother to keep track of.

• Liabilities are moneys owed that provided assets or represented losses of the enterprise.

– Providing financial statements

4. Production:• This is what you are trained for here at the Art Institute• In your field, you need to learn to predict future activity so that

you can have the right amount of resources for your customers.

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5. Quality Control:• In a small operation, this may fold seamlessly into your

production operation. • When quality control is working, I recommend you get

customer testimonials.6. Public Relations:• This is where marketing drives in business.• This is where you make your mark in the community to

establish your presence.7. Executive:• You, the executive, establish the business.

– What is produced or served?– The corporate culture.– The logistics of the entity, itself. We will discuss choice of entity later.

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Systems, the Path to Freedom

• Do you want to run your business or be in your business? The issue here is one of being in control versus being at the mercy of your business.

• The successful entrepreneur works on their business.

• The employee works in a business. • It is okay to work in your business, but to be

successful, you must work on your business.8

Systems are the Key

• When you establish systems for your business, you can delegate functions and know that they will operate whether or not you are around. A system is a set of written procedures which a reasonable person can learn and follow. When properly performed these procedures produce consistent results for similar inputs.

• Understanding the flows of a business will help you establish successful systems.

• With successful systems in place, you can take time off to recharge, vacation, and/or put your money to work for you.

• With successful systems others are empowered to make decisions in your abscense.

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Accounting – Misunderstood and/or Forgotten

• A typical approach to starting a business is to ignore accounting until the owner has time or money to handle it. Often the owner does not have sufficient knowledge of bookkeeping and accounting issues to properly set up their accounting systems. This is a situation where an ounce of prevention can be worth a pound of cure.

• The income and sales tax folks love accountants because accountants record activity. And, the tax folks can tax what they can measure.

• Businessmen hate accounting because the government can tax what they can measure.

• Businessmen hate accounting because it costs money and doesn’t increase profits when they don’t understand what the numbers mean.

• Businessmen hate accounting when they don’t understand it. Typically, they won’t deal with it. They turn the function over to a bookkeeper; and, then they run the risk that their bookkeeper embezzles from them.

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Accounting - the Asset

• The purpose for managing cash flow is to achieve your dreams.

• The accounting function produces reports. • Two important reports are the following

financial statements (see sample statements) :– Profit and loss, (or income statement) and – The balance sheet.

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Definitions of Financial Statements• The profit and loss statement is a report of the results of activity over time.

It is like measuring the volume of water flowing in a river.• The balance sheet is a statement of the amounts of assets, liabilities, and

owner’s equity at a point in time. It is like measuring the level of the river at a point in time.– Assets are resources that are or should be available to the business for use in

creating profits and other activities. Cash and inventory are assets. Some assets are treated as balance sheet items while others are expended directly to profit and loss. For example, a stapler might last for five years. However, its value is too small to bother to keep track of.

– Liabilities are moneys owed that provided assets or represented losses of the enterprise.

– Equity is the portion of a balance sheet that is left over after measuring assets and liabilities. It is the result of money invested by the owner, money withdrawn by the owner and the sum of profits and losses over the years. In a corporation, owner withdrawals are called dividends.

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• Another set of information that helps you better manage your business is called financial ratios. Financial ratios measure one set of numbers against another set of numbers. These numbers vary over time in relation to how the business is performing. Therefore, they can be used to develop suggestions for corrective action. Examples of how ratios can be used:– If you know how much inventory it takes to support your sales, then

you can order the optimal amount to save money and maximize sales.– If you sell on credit, knowing how long people take to pay their bills

helps you manage cash flow.– When you buy on credit, knowing how long you can make vendors

wait to get paid will help you manage relationships.– The ratio of costs of goods necessary for your sales should be well

understood. Food should be 1/3 of your restaurant’s sales price; labor another 3rd.

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Accounting Software• When you are ready to start your business, take a class on operating

the accounting software that you choose to use. For example, QuickBooks is commonly used. Many QuickBooks professionals offer courses for modest fees. You can also check with SCORE, http://www.sacscore.org/content/workshop-schedule and community colleges. (SCORE is an excellent resource for new business owners.)

• When you can use the software, you can control your bookkeeper.• Do not be your own bookkeeper any longer than is necessary. A good

bookkeeper will cost you $15 to $50 per hour. The time you spend getting customers, refining systems, producing, and assuring high quality controls should be much more valuable than that.

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Accounting’s Purpose

• With all this information in place, you improve your ability to spend marketing dollars wisely and to coordinate marketing with production activities. When production, marketing, and accounting work together, your profits improve and you can better manage cash flow.

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Cash Flow Compared to Profits • Some businesses are very profitable but have terrible cash flow.• Some businesses are unprofitable but have great cash flow.• Profit is the sum of a flow of activity over time.• Cash flow is the cash portion of that activity.

• In commercial activity it is common to sell a product or service today, and get paid later.• In many businesses it is common to purchase something today and pay for it later. • These differences cause profit statements to differ from cash flow statements.• *Incurred means that the activity is complete such that the vendor has the right to be

paid.

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Profit & Loss Cash FlowSales Earned CollectedLess Expenses Incurred* PaidNet Income (Loss) Net Profit Net Cash Flow

Cash Flow Management Particulars• Cash flow is managed by accelerating inflows and slowing outflows• Demanding cash from customers can cost you business. The credit card

industry exists on this issue. – Also, factoring companies and banks can help accelerate cash flow. Each solution

comes with a cost. A factoring company buys the right to collect unpaid invoices that a company has earned but not collected. For example, I sell a widget for $500. The factoring company pays me $400 for the right to collect the $500 from my customer. If in 30 days the factoring company collects the $500, they will reimburse me $80. I get $480 out of the $500 original invoice. If, however, the factoring company has to wait 60 days to collect the $500, then I only get a total of $460. That is because the factoring company is earning 4% per month. I remain liable to the factoring company in the event that the invoice proves to be uncollectible.

• Slowing cash flow to vendors can cost money or cost you your vital supply of goods or services.

• The key is to manage cash flow timing to optimize your situation.

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Some Data on Embezzlement• Trust your bookkeeper, bartender, sales clerks at your own peril.

– Put procedures in place that create accountability• Know how to control your cash:

– Who has access?– Who counts it?– Who reconciles your bank statements?

• Controlling sales:– What gets sold for cash goes into the cash register.– All money that you collect (cash, checks, credit charges, etc.) goes into the bank.

• Controlling expenses:– Employee compensation goes to real employees for actual services rendered. There

have been cases of phony employees getting paid. The checks are then cashed by someone else in the organization.

– Vendor compensation goes to real vendors who provided legitimate goods and services at an agreed upon price.

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Setting Up Your Own Business• We have many choices for how to set up our businesses:

– Sole proprietorship – see explanation on next page– Partnership (2 or more owners)

• General (All partners are liable for the debts of the partnership. This can be a problem if Partner A takes on debts that the other partners (B and C) eventually have to pay off.)

• Limited (one partner is personally liable for all debts of the partnership. Limited partners can only lose their investment. However, limited partners may not participate in the management of the partnership.)

– Corporation• C Corporation (Pays taxes, can have complex ownership)• S Corporation (No income taxes to pay, must be owned by US citizens or limited types of

trusts)

– Limited Liability Company• Taxed like a sole proprietorship, partnership, or corporation - your choice• The legal protection of a corporation• Complex extra set of taxes in California once gross income exceeds $250,000

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What Type of Entity is Best?• Sole proprietorships are easy to start. The only cost is your license to

operate and the cost of a fictitious name. The license is obtained from the city. The fictitious name is filed with the county and you have to advertise the filing in a local newspaper for four weeks. You are personally liable for any damages or losses of your business. Good luck if you get sued or are under insured.

• Corporations are a separate legal entity. The purpose of incorporating is to protect yourself from losses of the corporation (in excess of your investment). If you are disorganized, this may not be a good choice. The co-mingling of your personal activity with your corporate activity can make you personally liable for losses of the corporation. Before incorporating seek the council of a knowledgeable lawyer and CPA. The CPA will explain the different benefits of setting up as a C or an S Corporation. The lawyer will help you set it up to protect you against creditors going after your personal assets.

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Questions and Notes

• ________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________Kenneth Cone, CPA (408) 859-3109 or ken@order-from-chaos.com

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Bio• Kenneth R. Cone has been a CPA since 1981. He has provided his

services in both the public and private sectors. Ken has extensive entrepreneurial and small business experience. He owned a CPA practice in the SF Bay Area for nearly 17 years. During that time, Ken provided invaluable accounting and consulting related services to the small business community. Currently, Ken has a CPA practice here in the Sacramento Metro Area where he delights in helping businesses overcome obstacles so that they can thrive. Ken also holds the positions of CFO, and Administrative Partner to two Silicon Valley firms.

• Ken enjoys running, educating, and spending time with his family.• He is a member of Sacramento Metro Chamber.

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