Cash Flow Planning: Expenditure and Dealing with Deficits

Having looked at income, we now turn to expenditure. Here, there is tends to be more certainty, especially with regard to fixed costs (the costs we incur whether or not we have any work). For example, we know what rent or rates we are going to pay. We know what our utility bills are going to be. We know how much we’re paying for our phone. All of these tend to be regular payments that can be entered into the monthly columns.

Of course, if we are working from home and charging a proportion of the household costs to the business, we can choose to do this annually rather than monthly — or even to waive the charge altogether until the business is established. But if we do this, we have to remember we are giving ourselves a false picture when assessing how successful we have been.

The variable costs (those associated with a particular piece of work) are a little more difficult but for each income figure we enter, we should be able to estimate the related costs. These need to be entered at the time they are incurred (or at least paid for) which will often be before the income arrives.

To finish the statement, we need an opening balance for the beginning of the year and a carried forward figure at the end of each period (month). Remember that we do not start each month afresh. If we have a deficit at the end of one month, that is the opening balance at start of the next month.

OK, I think it is now time for a picture, or at least a chart. Let’s have a look at an example (and remember, the only purpose of these numbers is to illustrate the points, so we shouldn’t get hung up on whether they make sense individually or not).

Example 1 (click on chart to enlarge)

In this example, we have the four different income streams: six articles paid monthly between August and January; Amazon sales which come in bimonthly from October onwards; direct sales to the public which vary depending on events per month; and fees for running a writing course every two months. We see that the income varies between £20 and £370 per month.

For expenditure, we have a regular monthly contract for phone and internet; we have mileage costs and printing costs associated with the course, the former occurring in the same month and the latter a month earlier in each case; and we have a regular ‘drawing’ to cover our personal expenses. Whether this is a salary that we are paid as an employee of a limited company, or whether it is a drawing we make as a sole trader is irrelevant here. This is the money we need to live (and again - these are examples only, not real figures). We see that our total expenditure is fairly fixed at between £550 and £580 per month.

We have started the year with an opening balance (i.e. funding) of £4000. At the end of the year, our closing balance is zero. This means that we are projecting a loss of £4000 during the year. But remember, we are talking here about cash flow. What this tells us is that if we start with £4000, we will have enough cash to last the year but that we will need to sort out more funding (or raise income, or reduce expenditure) at the beginning of the next financial year.

Let’s suppose we don’t have a £4000 pot to start the year off. What happens if we only have £3000?

Example 2 (click on chart to enlarge)

 

In this case, our cash flow goes negative in December and we need to find more funding at that point but we have demonstrated that we can start with a smaller pot and keep the business running.

If we have our cash flow set up in a spread sheet, as I’ve shown here, it’s very easy to play the ‘what if’ game by changing some of the figures and seeing what the effect is on the bottom line. For example, try pushing up the income or reducing the expenditure to see what happens. This is also useful for crystallising exactly what we need to do to make the business a success.

As always, note that I am not an accountant or a lawyer, just a long-term business owner, talking about my own experience. If you are unsure about anything, always take advice from an appropriate professional.

Cash Flow Planning: Income

Like the P&L and balance sheet, cash flow can be looked at historically. In this context, it is used to show how changes in the balance sheet have occurred over the past year. However, I believe it is much more important as a planning tool and it is this aspect we are going to look at in the next couple of articles.

Cash flow is used to examine the expected flow of money over a given period of time, which may be years, but will certainly be months. It allows us to identify our cash requirements, to spot any periods when we can expect a deficit and then to plan in advance the funding of that deficit.

It not part of the record-keeping needed to work out how much we owe the tax man (or vice versa), so a cash flow plan is not a statutory requirement. However, I would suggest it is one of the most important tools in our box. It is particularly critical if we are likely to incur high expenses (which may be the case when we are starting a business) or if there is expected to be a time lag before payments will be received. This sort of time lag is certainly one that most writers will recognise.

A cash flow plan is an easy document to prepare and is best done either on paper (although this means we will have to do the sums in our heads) or in a spreadsheet. It can also be done within a computerised accounting package, but I’m not sure it’s worth the bother. Personally, I would opt for the spreadsheet every time. Set it up with a column for each month. Start with a year and when that’s done, we can decide whether we need to carry it forward for a second year or more.

The plan can be based on actual or projected figures, and will often be a mixture of both. We often know what our expenses are going to be, while we merely have expectations on levels and timing of income. We start by brainstorming all the income streams we are hoping to tap during the next year; together the the expected amounts and mostly importantly the timing of receipt. This is not about raising invoices; we can’t pay a bill with an invoice. This is about getting money into the bank. And it’s also about knowing and understanding the payment systems operated by our various clients.

Let’s take an example:

Suppose we are commissioned to write a series of monthly articles for a writing magazine and we are offered a fixed fee per article. The series will run from July through to December. The delivery date for the first article is April and then monthly thereafter. We will raise our invoices on a monthly basis from April onwards. There are a number of possibilities for payment:

·        The magazine may pay within a set period of invoice date; this may be 30 days, it could be 60 days, it could even be 90 days. The key thing is to know what to expect. Let’s assume they pay within 30 days of invoice date. The money should be paid at the end of May and therefore would be available to deal with June’s bills.

·        The magazine may pay at the end of the month of publication. In this case, the money would be paid at the end of July and would be available for August’s bills.

So there is a possibility that work carried out in April will not provide any positive cash flow until August. Of course, with a monthly contract, we know there will be money coming in each month from then on, for as long as the contract exists and for the three or four month time lag thereafter.

If we think about other income sources, there is usually a delay associated with payment. For example, money from sales of ebooks via Amazon or Smashwords is delayed twice: firstly until a threshold amount of sales has been made; and secondly according to payment policy. Amazon has varying thresholds depending on currency and payment method, but once the threshold is reached, payment is usually made 60 days following the end of the calendar month in which the threshold is reached.   That’s quite a time lag to build in.

Of course, some income can be obtained up front: cash from books sold direct to the reader; fees paid by students on writing courses or seminars; advances from publishers on commissioned books (I have been told that these still exist occasionally) are three examples I could think of. On the other hand, the royalties paid by publishers on traditionally published books can be months, if not years, down the line.

Once we have identified all likely income streams and the timing of expected payments, each stream in listed as a separate row on the spreadsheet and the income payments listed in the appropriate column. We can then calculate our expected income by month over the chosen time period.

Next week, we’ll look at expenditure planning (depressingly easier to do than income planning) and dealing with cash flow deficits.

As always, note that I am not an accountant or a lawyer, just a long-term business owner, talking about my own experience. If you are unsure about anything, always take advice from an appropriate professional.