Proper cash management can significantly improve your financial plan. Too many business owners do not have a solid cash flow strategy and as a result, feel anxious and confused. As tax season starts to get underway, this will only get magnified. Taking the time now to map out your cash flow can save you stress and set you up better for financial success—not just during tax season, but all year long.
Where Are the Physical Dollars?
Cash Flow is arguably one of the most important financial planning topics both for business and personal finances. Without income (or organized income), there is no business or money for the family. Business owners have done the work to create a business that solves a problem for people but then overlook how to manage the income coming through the door. Clear cash flow management allows you to focus on growth in the future while avoiding unnecessary surprises or setbacks that could occur on a given day.
One of the most common examples is when small business owners use their family checking accounts for personal and business expenses. It might feel easier to leave everything combined, but it will inevitably create confusion about which money is meant for the household and which is meant to grow the business. This system can sometimes be good enough to keep using while business is good, until tax time comes and your accountant starts asking questions. Technology and other tools have begun to help this system some, but ultimately you need to separate the business and personal finances.
Open a business checking account at your bank and exclusively use that for business income and expenses. Not only will it help mentally keep the money in order, but it’s also easier to track expenses, manage business cash flow, and provide accurate information to your accountant. You need to be able to distinguish between what assets the company is using to grow the business with what assets are personal to the family. You may think that is not completely necessary, but I wonder if your spouse (or anyone else you share finances with) would say the same thing.
Whose Cash Is It Anyway?
Having extra cash in “reserve” is a good indicator of financial health. Whenever professional investors look into businesses, the amount of cash on hand and the level of cash flow are vital signs of the health of the company. This should apply to your business and personal finances as well. Sometimes this is called an emergency fund or a rainy-day fund, the name doesn’t really matter. What is important is that there is money set aside as a backup to your checking accounts. We can debate how much but having at least 3-6 months of expenses can be a healthy start.
The reason some people do not have cash reserves is related to the idea of margin. Why should we have money sitting around doing nothing? That is the typical response from a business owner who loves investing in new ventures. This could also occur with families who spend everything they make, and as a result, have no extra cash. Cash reserves are an investment to “buy cash” to reduce the risk of negative outcomes in the future. If you had one year’s worth of expenses sitting in cash, would you be as upset if this month had fewer sales than normal?
Some other businesses and households prefer extra cash. Having $50,000 or $100,000 (sometimes more) in cash can give them the mental freedom we are talking about. Many times, this number is less about you and more about those you share finances with. One of the easiest ways to calm your spouse’s (or business partner’s) anxiety around money is to show you have 10 times the monthly expenses in a savings account “just in case”. Having margins, or reserves, is how people stop letting money control their lives.
Cash Is an Investment.
Cash flow is king. Each decision you make about where cash goes is itself an investment. Start with cash reserves and buy the financial peace of mind your household and business need in the short term. Then move to other investments. How much cash is allocated to retirement accounts? How much back into the business? How much is routed to future expenses like college for the kids or a beach home? Forget about the specific investment (stocks, bonds, real estate) that you will buy for a minute, first focus on what your cash flow will be spent on.
We met with a couple this week whose primary goal is to retire comfortably. Nearly every scenario showed their current retirement contributions had put them way ahead of schedule. So, we spent the meeting talking about education planning and buying land instead. Once you have a clear picture of your cash flow, it becomes easier to adjust as your needs and goals evolve.
At the end of the cash flow management is usually investment management itself. The money we contribute to retirement accounts will likely be invested differently than your cash reserves. Cash in the savings account will likely stay “as cash”, or buying short-term CDs, Treasuries, or Money Market Funds. Retirement accounts (for those years away from retirement) would focus more on stocks and bonds. Perhaps you have a real estate business you want to fund and put more dollars towards a new rental property. Many business owners think this step is the “only part” of a financial advisor’s job, but honestly, it’s usually the last (and simplest). The hardest part is to designate where the dollars are going and do the work to make sure each month they get there.
Organize Your Money.
When it comes to the cash in your personal or business economy, ultimately keeping things organized is half the battle. Having separate accounts for personal and business expenses is a big step in the right direction. Then slowly start building other accounts by each goal you set. Start with developing a healthy emergency fund both personally and within the business, then move to longer-term goals like retirement, education, etc. Only then should you worry about what investments to purchase, and whether those investments will help you reach your goals. Cash management is not complicated but can be rewarding if done correctly.
TC Falkner 