At this point in the series, we have looked at the three cash flow tools to create visibility around each of the key drivers of cash flow.
We have started to get the CEO and the management team more informed about what's been going on with the cash.
We have also helped create the view of what lies ahead for our cash flow.
We have incorporated the cash flow projections into the monthly financial reporting process so everyone can clearly see what is likely to happen to the cash over the next six to twelve months.
Now it's time to drill down on what these schedules/tools are telling us about our cash flow.
Remember, in addition to helping management and lenders better understand our cash flow, we want to put goals and strategies in place to make smart decisions about how we use that cash going forward.
And we want to put strategies in place to drive cash flow higher.
There is a seven-step review that will help you make that happen.
In this post, I will go into detail on step 1.
- Understand the Peak and Trough Cash Months
One of the bigger mistakes you can make in managing cash flow is to make purchase decisions, or make decisions that commit your financial resources, based on how much money you have in the bank at any given point in time.
To make smart decisions about your cash you need to understand your peak and trough cash months.
The peak cash month is that month (or months) where your cash balance is generally at its highest point during the year. The trough cash month is just the opposite. It is the month (or months) where your cash balance is generally at its lowest point during the year.
Here's where many businesses make a big mistake with their cash flow.
When they are in their peak cash month, they feel really good about their cash flow because they have a nice cash balance. Then they make decisions that use or commit that money not realizing that they are using cash they will need in order to get them through the trough month.
The result is a "cash flow problem" when the inevitable trough month arrives and there is not enough cash to get through that period. Hello!
In my opinion, this is one of the major killers of small businesses today.
It's easy for the CEO or others to fall into this trap.
It's your job as the CFO to help them avoid that mistake.
The image above is from a service company I worked with. It's a graph of their cash balances by month (in thousands).
Their peak month, from a cash balance perspective, was January. The balance was generally in the $800,000 to $1,000,000 range during the first three months of the year.
The trough month each year was in the $200,000 range during the summer (July to September or so).
The difference between the peak balance and the trough balance was about $800,000. The minimum cash target was $150,000. That meant the peak cash balance in January had to be at least $950,000 in order for them to have a trough cash balance of at least $150,000 in August.
The Graph Made It Crystal Clear
Once I put the historical and projected cash flows in front of the CEO each month, and really honed in on how this affected how we made decisions about cash in January, he got it.
I never had to nag and preach about the subject any more.
The projections showed everyone exactly where the cash balance should be at the peak and trough months. This provided the information we needed to manage the business properly and to protect the trough month.
It made it crystal clear how the seasonality of the business affected cash flow each month of the year.
And most importantly…
It made it clear to the CEO that we could not just spend the money we had sitting there in January.
Look at your historical and projected cash flows so you can educate everyone on your leadership team about your peak and trough cash months.
And use that information when you are making decisions that will impact your cash balance later in the year.
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