1 00:00:04,630 --> 00:00:10,720 The current ratio Quick Ratio in historical cash balances are all useful estimates of whether you need 2 00:00:10,720 --> 00:00:13,640 a loan or some other source of funding in the future. 3 00:00:13,660 --> 00:00:16,760 The biggest weakness is that they are all backwards looking. 4 00:00:16,840 --> 00:00:22,750 All decisions are based on the future and require analysis of expectations of that future. 5 00:00:22,750 --> 00:00:27,340 There is a reason the windshield of your car is bigger than your rear view mirror drive your company 6 00:00:27,340 --> 00:00:29,710 by focusing on what's ahead of you. 7 00:00:29,710 --> 00:00:34,790 The gold standard for estimating your need for loan funds is a cash flow projection. 8 00:00:34,810 --> 00:00:39,580 I'll talk you through how to create one a cash flow projection template is also included in the course 9 00:00:39,580 --> 00:00:40,560 contents. 10 00:00:40,750 --> 00:00:46,090 Before we get into creating a cash flow projection I want to explain how cash flows in and out of your 11 00:00:46,090 --> 00:00:52,220 company think of managing your company's cash as coordinating three tanks of liquid. 12 00:00:52,290 --> 00:00:57,360 In fact a company has access to cash is often referred to as its liquidity. 13 00:00:57,360 --> 00:01:00,180 There are three main sources and uses of cash. 14 00:01:00,180 --> 00:01:03,280 Think of each as a tank of cash investments. 15 00:01:03,330 --> 00:01:07,980 The investing tank is the amount of money your current and potential owners have available to invest 16 00:01:07,980 --> 00:01:13,910 in the company the operations tank is your business is checking account the amount of cash in the tank 17 00:01:13,910 --> 00:01:16,840 rises and falls with the cash conversion cycle. 18 00:01:17,000 --> 00:01:21,320 The financing tank is the money you can borrow from banks friends and family. 19 00:01:21,320 --> 00:01:25,790 A business starts when the owners transfer their liquid cash to the operations tank. 20 00:01:25,790 --> 00:01:29,320 The business spends this cash for operations reducing the tank. 21 00:01:29,450 --> 00:01:34,330 Soon the business produces a return on the cash which starts to fill the tank backup. 22 00:01:34,400 --> 00:01:39,890 Successful businesses have so much cash coming into the tank that they can flow it back to the owners 23 00:01:39,920 --> 00:01:42,350 or make big investments for growth. 24 00:01:42,350 --> 00:01:46,700 Once lenders are confident that you can keep your operations tank filled they are willing to allow you 25 00:01:46,700 --> 00:01:49,270 to tap into their tank of funds when you need it. 26 00:01:49,280 --> 00:01:55,430 Now the owners tank isn't the only spare tank available when you need it for cash for growth or investment. 27 00:01:55,550 --> 00:02:00,800 A cash crunch happens when the operations tank is draining and the owners have already drained everything 28 00:02:00,800 --> 00:02:02,540 they had in their investment tank. 29 00:02:02,540 --> 00:02:06,950 Lenders get concerned that they won't get their money back from the company so they shut off their pipeline 30 00:02:06,950 --> 00:02:08,860 of cash to the company. 31 00:02:08,930 --> 00:02:14,240 I was a bank CFO during the Great Recession and saw companies get into this cash crunch situation. 32 00:02:14,240 --> 00:02:19,310 Ironically what often caused the cash crunches were good economic times. 33 00:02:19,460 --> 00:02:23,000 Owners saw lots of opportunities to make profits in their companies. 34 00:02:23,000 --> 00:02:26,060 They drained all their personal cash reserves into the company. 35 00:02:26,270 --> 00:02:30,240 At the same time they borrowed all they could and made big investments. 36 00:02:30,290 --> 00:02:36,050 Everything worked as long as the economy allowed the operations tank to quickly refill with cash. 37 00:02:36,080 --> 00:02:42,410 However the economy repeatedly goes up and then goes down when it goes down the operations tank fills 38 00:02:42,410 --> 00:02:47,810 much more slowly with no reserves in the investment tank and no more access to the borrowing tanks. 39 00:02:47,810 --> 00:02:53,930 The operation tank went down the expense drain our natural optimism as business owners continued to 40 00:02:53,930 --> 00:02:55,550 see opportunities. 41 00:02:55,550 --> 00:03:00,680 Always keep some reserves in the investment and financing tanks you may need it for business downturns 42 00:03:00,680 --> 00:03:02,430 or unexpected opportunities. 43 00:03:02,450 --> 00:03:05,650 You need cash reserves when you start a growth strategy. 44 00:03:05,720 --> 00:03:10,850 The three tanks of cash are the same categories on your statement of cash flows the Statement of Cash 45 00:03:10,850 --> 00:03:14,930 Flows provides a historical look at where cash came from and where it went. 46 00:03:15,260 --> 00:03:20,750 Operational cash flows or sales outflows or most of the expenses on the income statement also known 47 00:03:20,750 --> 00:03:22,400 as the profit loss statement. 48 00:03:22,400 --> 00:03:28,250 One interesting note in cash outflows is that interest paid on loans are included with cash from operations 49 00:03:28,280 --> 00:03:32,620 not cash from financing or the principal portion of the loan payments go. 50 00:03:32,630 --> 00:03:37,670 This was subject to a contentious debate when the FAS B who makes U.S. accounting rules required the 51 00:03:37,670 --> 00:03:42,230 addition of a statement of cash flows for audited financial statements in 1987. 52 00:03:42,230 --> 00:03:47,270 You can make a case for it being an operations or financing but fast B said financing and so that's 53 00:03:47,270 --> 00:03:48,390 where it goes. 54 00:03:48,410 --> 00:03:53,900 Investing cash flows are used for things like buildings and equipment investments like stocks and bonds 55 00:03:53,900 --> 00:04:00,740 are also investment cash flows financing cash flows where bank loans go advances or proceeds from bank 56 00:04:00,740 --> 00:04:02,370 loans or cash inflows. 57 00:04:02,510 --> 00:04:06,640 The principal payments on loans are cash outflows. 58 00:04:06,650 --> 00:04:09,700 This is a summarized format for the cash flow statement. 59 00:04:09,740 --> 00:04:15,470 It starts with net cash from operations followed by net cash from investing and financing activities. 60 00:04:15,470 --> 00:04:18,680 You can learn a lot by looking at net cash from operations. 61 00:04:18,860 --> 00:04:24,160 If it's negative it means your company's core operations didn't produce positive cash flow. 62 00:04:24,200 --> 00:04:26,830 You can be profitable but still be bleeding cash. 63 00:04:26,900 --> 00:04:31,880 The negative cash from operations needs covered by your beginning cash balance or by net inflows from 64 00:04:31,880 --> 00:04:33,890 investing or financing. 65 00:04:33,890 --> 00:04:38,750 Another common thing to see on a statement of cash flows is a big cash outflow for buildings or equipment 66 00:04:38,810 --> 00:04:44,110 and a big cash inflow in net cash from financing from the loan to buy those investments. 67 00:04:44,150 --> 00:04:49,100 The three cash flow categories in this summarized statement format are the same three categories that 68 00:04:49,100 --> 00:04:54,820 will be used to my cash projection template all the information you gathered from earlier slides on 69 00:04:54,820 --> 00:04:59,200 historical cash flows can now be used to project future cash flows. 70 00:04:59,440 --> 00:05:02,830 The Course materials include a cash flow projection template. 71 00:05:02,830 --> 00:05:07,150 I can't fit the whole template in one slide so I've broken it into sections that I'll discuss in the 72 00:05:07,150 --> 00:05:08,620 next few slides. 73 00:05:08,620 --> 00:05:13,480 This isn't a course on the specifics of preparing the Statement of Cash Flows or cash flow projections. 74 00:05:13,570 --> 00:05:15,760 So I'm not going into each line item. 75 00:05:15,760 --> 00:05:19,840 I will show the importance of each section and how to use the projection to determine whether you may 76 00:05:19,840 --> 00:05:20,790 need a loan. 77 00:05:20,830 --> 00:05:25,330 The first line of the projection is you're beginning cash balance the beginning cash balance for the 78 00:05:25,330 --> 00:05:30,370 first column of numbers is the cash balance from your accounting software the beginning balance for 79 00:05:30,370 --> 00:05:34,290 all other columns is the ending cash balance from the previous column. 80 00:05:34,390 --> 00:05:40,000 As we work our way to the bottom of the projection I'll show you where those numbers come from you want 81 00:05:40,000 --> 00:05:44,380 to check this balance for each time period of the projection to make sure it doesn't drop below a level 82 00:05:44,380 --> 00:05:45,910 you are comfortable with. 83 00:05:45,910 --> 00:05:51,040 This sample projection uses monthly time periods but you can do projections by weeks months quarters 84 00:05:51,040 --> 00:05:52,120 or years. 85 00:05:52,120 --> 00:05:55,510 The tighter your cash the shorter the periods you want to project. 86 00:05:55,540 --> 00:06:00,630 For example you would prepare this for the next six weeks if your cash is tight and your cash balances 87 00:06:00,640 --> 00:06:04,210 significantly rise and fall within a month. 88 00:06:04,300 --> 00:06:07,650 The first section shown here lists operational cash inflows. 89 00:06:07,690 --> 00:06:14,890 The vast majority of which are usually cash received from the sales of goods or services the next section 90 00:06:14,890 --> 00:06:21,040 are operational cash outflows the sum of all your operational cash inflows and cash outflows total your 91 00:06:21,040 --> 00:06:22,980 net cash from operations. 92 00:06:23,020 --> 00:06:24,970 This total is very important. 93 00:06:25,000 --> 00:06:30,130 It tells you if your business is producing positive cash flow from your standard operations you must 94 00:06:30,130 --> 00:06:32,410 find supplemental sources of cash for the company. 95 00:06:32,410 --> 00:06:38,290 If you have negative cash flow from operations positive operational cash flows allow you to make large 96 00:06:38,290 --> 00:06:45,360 purchases pay down loans or distribute cash to owners many cash flow projection templates ignore or 97 00:06:45,360 --> 00:06:51,630 don't breakout two very important types of Cash Flows financing cash flows and equity cash flows. 98 00:06:51,630 --> 00:06:56,010 You need to understand your operational cash flows before you can start planning your financing and 99 00:06:56,010 --> 00:06:57,420 equity cash flows. 100 00:06:57,450 --> 00:07:02,700 I recommend first entering the rows for our cash from operations section and any required finance payments 101 00:07:02,700 --> 00:07:04,550 in the financing section. 102 00:07:04,620 --> 00:07:09,540 You now have critical information to make major financial planning decisions. 103 00:07:09,600 --> 00:07:13,980 Do you have negative operational cash flow or not enough cash for a large investment. 104 00:07:14,010 --> 00:07:18,150 This is where you would project how much cash you would need from borrowing money or having the owners 105 00:07:18,150 --> 00:07:20,490 invest more equity into the company. 106 00:07:20,580 --> 00:07:25,920 The sooner you can identify potential cash issues the more options you have to adjust your cash flows 107 00:07:25,920 --> 00:07:27,690 to minimize those issues. 108 00:07:27,690 --> 00:07:31,550 Preparing a cash projection provides you precious time to line up loans. 109 00:07:31,710 --> 00:07:36,180 You don't want to be scrambling with tight cash or working against a deadline to get a loan in place 110 00:07:36,390 --> 00:07:39,430 before you run out of cash or miss an opportunity. 111 00:07:39,450 --> 00:07:43,830 The projection estimates when you will need the funds and you can work with your banker to start the 112 00:07:43,830 --> 00:07:45,510 process of getting those funds. 113 00:07:45,570 --> 00:07:50,570 It may even show you have a little time to wait before you start the loan application process. 114 00:07:50,580 --> 00:07:53,510 What if you have a positive net cash flow from operations. 115 00:07:53,520 --> 00:07:57,850 Congratulations you have some exciting options for how to use that cash. 116 00:07:58,050 --> 00:08:02,940 You can't invest it back in the business pay down lines of credit or make large principal payments on 117 00:08:02,940 --> 00:08:03,870 other loans. 118 00:08:03,870 --> 00:08:07,380 You could purchase equipment or distribute the cash to owners. 119 00:08:07,380 --> 00:08:11,790 The sample company above projected meeting in advance on their line of credit in January. 120 00:08:11,790 --> 00:08:14,630 They could then pay that off in April which is good to model. 121 00:08:14,640 --> 00:08:20,580 As I'll explain later you need to periodically pay a line of credit to zero according to the loan agreement. 122 00:08:20,580 --> 00:08:26,040 I cannot overemphasize how important a cash flow projection is to business planning your lender will 123 00:08:26,040 --> 00:08:31,290 want a cash projection for the loan application but don't look at it as just another form to fill out. 124 00:08:31,290 --> 00:08:35,370 It could be what allows you to seize opportunities that you might have otherwise had to pass on.