The Virtual CFO

Happiness is a Positive Cash Flow – Managing Your Cash Flow

It would be safe to say that every small business experiences cash flow problems from time-to-time.

You can mitigate cash flow problems by actively budgeting for and managing your cash flow.

On a regular basis, you need to estimate the cash you expect to receive from customers, identify the payments that are due (payroll, taxes, vendor payments, etc.), and then create an analysis that compares the estimated cash inflows to the payments that are due. From this analysis you create a cash flow budget.

The cash flow budget will provide a guide for you to use to manage your company’s cash flow.

If the analysis shows that a positive cash flow is expected, you can budget to pay all of your obligations on time and take comfort that there will be funds available to do this.

If the analysis yields a negative cash flow, you will need to prioritize your payments in the cash flow budget in order to conserve your liquid funds.

Happiness is a Positive Cash Flow – What is Cash Flow?

Cash flow is different from income.

Income is the difference between sales revenue (collected and uncollected) less expenses (paid and unpaid).You can make a million dollars in income and still end up bankrupt if you aren’t able to collect the cash from customers after the sales.

Cash flow, on the other hand, is the difference between the actual cash a company receives from customers less the cash actually paid for expenses (payroll, vendors, taxes, etc.).

Analyzing and managing cash flow is particularly important to small businesses because there is such a small margin for error when cash flow is tight or negative.

Reflections on BarCamp Nashville 2008

The Virtual CFO blog was born on June 17, 2006 at the urging of Bill Seaver of MicroExplosion Media. I had mentioned to Bill that I wanted to create an electronic newsletter for the entrepreneurial public accounting firm I was opening. Bill recommended that I start a blog instead. He took the time to explain to me the advantages of Web 2.0, which is why I decided to give blogging a try. For almost two and a half years, this blog has been very valuable asset for me and my practice.

A few weeks ago, Bill blogged about the session he and Steve Horton would be presenting at BarCamp Nashville 2008. I read Bill’s post, but really didn’t think much about it until my wife asked if I would be attending. I studied the BarCamp Nashville website and decided to go. I’m glad I did and I had a great time at the conference.

One of the things I liked about BarCamp was that each session was only 25 minutes long. This meant that the speakers had to be concise and to the point. The limited time frame kept the sessions from dragging on. Surprisingly, all of the speakers kept my attention from 9:00 am until the event was over at 3:55 pm. I was tired at the end of the day, but it was a good kind of tired.

I was impressed with the depth of the content the speakers covered in the short period of time they had to make their presentations. I took eleven pages of notes during the day and I walked away from all but one of the twelve sessions I attended with something practical that I could use with my blog or my company's online presence. (The one session that I didn’t was Matt Reed's wonderful presentation entitled “Inebriator: Rise of the Machines”. I just can’t think of a way I can use remotely controlled robots in my public accounting practice. And as a financial guy, I feel that $200 is a little steep for a robot beer pourer when I can do it myself for free <grin>)

The other aspect of BarCamp I liked was networking with other attendees. I enjoyed meeting and talking to others about their view of blogging, Web 2.0, and online marketing.

I will definitely be attending BarCamp Nashville 2009.

A Small Business Owner’s View of Raising Taxes on Those Making More Than $250,000

This isn’t meant to be political post. But as a CPA, I had a reaction to the coverage of the proposed tax increase and decided to write about it.

Joe the Plumber has brought to light small business owner’s troubled reaction to Mr. Barack Obama’s desire to raise taxes for anyone making over $250,000. However, I haven’t seen anyone in the media take the time to explain the full implications of this on small businesses.

Most small businesses are either S-Corps or LLC’s. The advantage of these organizational structures is that the owner pays taxes on income based on their personal tax rate, as opposed to the corporate tax rate. For 2008, the personal tax rate for an income of $250,000 is 35% and the corporate tax rate is 39%. So in its simplest form, the proposed tax structure will cost an individual making $250,000 an additional $10,000 a year in taxes.

With a LLC or S-Corp, the owner must pay income on the businesses net income, regardless of whether they pull any money out of the company for personal use or not. So if a company makes $250,000 in net income and the owner draws out $50,000, the owner still has to pay taxes on the company’s net income of $250,000 (and not just on the $50,000 he drew out for personal use). This is probably the most common unwanted surprise new S-Corp and LLC owners have in their first profitable tax year.

But there is more to this than that.

When a business buys an asset, the cost is not expensed at the time of purchase, but rather depreciated over the life of the asset. Depreciation is an accounting means of matching the expense of an asset with the use of the asset over the assets useful life. For instance, computers are 5-year assets. So if you purchase a $10,000 in computer equipment today, you would pay $10,000 in cash today and would only be able to take a depreciation expense of $2,000 in the current year (I’m leaving accelerated depreciation and Section 179 out of this for simplicity sake). This means that $8,000 of the purchase price of the computer is counted as income for the business in the year of the purchase, even though the cash was spent for an asset the company needs. Therefore, the owner must pay taxes on the $8,000 that was used to purchase assets for his business.

If taxes are raised, small business owners will be taking this into account in their business and personal tax planning. It is likely that they will choose to lower the investments they make in their companies in order to pay the higher tax on their income.

This is why the proposed tax increase would have a negative effect on small business growth.

Happiness is a Positive Cash Flow

When I was in college, I read the book And the Wolf Finally Came: The Decline of the American Steel Industry by John P. Hoerr.

This book tells of an embroidered pillow in the corporate raider T. Boone Pickens office that read, “Happiness is a Positive Cash Flow.” (Considering that Mr. Pickens hedge fund lost $1 billion his year and Mr. Pickens lost $270 million personally, he probably has a greater appreciation for this now than before).

At the time, I didn’t really grasp the significance of this sentence (like a lot of other things I learned in business school). After many years of small business operations and financial management experience, I’ve gained a deep respect for the wisdom in this saying.

Over the next few posts, I’ll be discussing cash flow and its significance to small businesses.

The Difference between Frugal and Cheap in Business Decisions

I was discussing accounting software options with a client this week. My client is currently using a basic accounting package for procurement, sales, production inventory, and billing. They are also using a industry specific operations software application for production planning and scheduling. One of the main inefficiencies of this arrangement is that the two programs do not communicate with each other, so each production order must be entered three times. Once in the accounting system when a customer places an order, a second time into the production planning and scheduling program when the order is released into production, and a third time into the accounting software when the order is complete (inventory used and being released to be billed).

In our conversation, we discussed the pros and cons of adopting an industry specific software package that would incorporate both accounting and operations in one program. One of the downsides of the industry specific software is that it is more expensive that the two basic programs the client is currently using.

At one point in the conversation, the client said to me “I don’t want to be cheap about this, but do want to spend as little as possible”. While driving back to the office, I thought that this is the difference between being frugal and being cheap when making business decisions.

Being “cheap” means choosing the least expensive option, regardless of whether the product is appropriate for your circumstances or not. Being “frugal” means spending as little as possible, while at the same time obtaining all the features in a product that your business needs to run more efficiently and effectively.

Often, being cheap cost the company more over time than if a frugal decision had been made.

Why Regularly Evaluating Your Business Plan is Important

The Entrepreneurial Mind blog post entitled "Know How Your Customer Thinks and How They Act" brings to light why entrepreneurs and small businesses must regularly evaluate, update, and revise their business plan as it relates to their products, services, and customers.

In this post, Jeff Cornwall discusses how there may be a difference between what your customers say and what your customers may actually believe or how they will act. Even though this post concerns businesses and their stance on environmental and health related issues, I believe that it is relevant for other features as well.

Let’s say you have watched the movie The Jerk with your friends. At the end of the movie, all of your friends express a desire to have a cup of pizza (it’s in the movie). The discussion among your friends leads you to believe that there may be a demand for cup of pizza. You conduct market research and decide that there is enough demand for the product to open a business based on the concept. You form a business plan based on your research and open a Cup-of-Pizza kiosk at the mall.

A few months after opening your business, it becomes evident that the actual demand for the product was much less than you anticipated. If you are completely dedicated to your initial business plan, you may have to eventually close your business if the sales of Cup-of-Pizza are not enough to sustain your business.

However, if you routinely evaluate, update, and revise your business plan, you may have discovered that there is demand for other products that can be offered with the infrastructure you already have in place.

For instance, you may have noted that people frequently ask if you sell noodles in a cup, which is an established and popular product in some parts of the United States. If you regularly evaluate your business plan, you would have identified noodles in a cup as a product for which there is demand and that your business could sell without any additional investment except ingredients. The combined offering of Noodles-in-a-Cup and Cup-of-Pizza could bring in enough sales to make your company profitable.

By evaluating, updating, and revising your business plan, you have identified a change in your target market ("exclusively pizza that is offered in a cup" to "food offered in a cup") that will help increase the likelihood that your firm will prosper.