Published January 2002

Keep a handle on finances with cash forecast

One of the painful discoveries that business managers come upon is that an economic turnaround — just the kind we are hoping for — can leave a business so short of cash that there is worry about making the payroll. How much of a problem increased sales could cause for your business depends on its financial structure, and this would be an excellent time to take a look at that structure by examining your balance sheet and, especially, your income statement.

You can use these to create a cash forecast — and that’s what you need to figure out if you can weather the recovery as well as you weathered the recession.

There isn’t anything really complicated about a cash forecast, but it does require a somewhat different perspective from the usual financial analysis.

There is no more vivid example of this than the data released during professional baseball’s recent “whine fest,” in which the owners told Congress that their poverty justifies their exemption from anti-trust laws.

According to their financial analysis, their numbers show that almost all of the major league baseball teams are losing money. And that, indeed, may be so, from the usual “bottom line” financial perspective.

Of course, if that were all there were to the story, you would have to conclude that the owners of the money-losing baseball clubs have to be the biggest collection of dummies this side of a crash-test laboratory.

It isn’t the end of the financial story, though, because the reports do not provide a look at these businesses from a “cash flow” perspective.

Most baseball franchises may operate at a loss, but they have positive cash flow or else the owners would cut and run. The fact that 25 of the 30 teams lost money last year, for example, doesn’t mean that the owners had to cough up cash to keep the clubs running. The reason is simple: There is a big difference between cash costs and non-cash costs.

Suppose, for example, you purchased a heavy-duty pressure washer for $5,000 for the purpose of renting it out. You expect it to last five years, so your depreciation cost is $1,000 a year. Rentals average $800 a year, so you are showing a loss of $200 a year, but your cash flow is positive.

In fact, it is $800 a year, because rentals represent incoming cash, and depreciation is a non-cash cost. You don’t have to write a check to anyone for it. Moreover, if, at the end of five years, though, you sell it for $2,500, you would be making money (a total of $4,000 in rentals and $2,500 in sale proceeds, less the $5,000 initial cost), yet you showed a loss for every year that you owned the investment.

Baseball franchises are similar, except on a much grander scale. Unlike most businesses, professional sports clubs can depreciate the value of their labor — that is, courtesy of the U.S. Congress, they can depreciate the value of their player contracts. As a result, their biggest single cost is depreciation, a non-cash item.

The goal of the baseball franchise owners, then, is this: show a loss every year that can be passed on to investors as an offset to their other income for tax purposes, but maintain a positive cash flow. That way, it is not painful to hold on to the investment until a buyer can be found that will pay more for it than they did.

For your own business it is equally important to distinguish between cash and non-cash costs. It is also important to figure out any time delays between cash out and cash in.

A company that buys wholesale produce and sells smaller quantities to restaurants, for example, may find that to survive in that market it must pay cash on delivery to its suppliers but offer “net 30” terms to its customers. This means that every dollar in sales is spent (cash out) at least a month before the restaurants pay their bills (cash in).

Unless you have the cash to cover the necessary purchases to support sales, of course, you are in trouble. And when sales increase, which we all want, we need even more cash. All of this should be taken into consideration as you put together a cash forecast.

The easiest way is to set up a monthly cash-in and cash-out list on a spread sheet, using what amounts have come in and gone out over the past year, and estimating what they will be if sales pick up. And if cash out exceeds cash in for any month, it would be a good idea to talk with your banker or your investors now, rather than later. They’ll appreciate it, and you.

James McCusker, a Bothell economist, educator and small-business consultant, writes “Your Business” in The Herald each Sunday. He can be reached by sending e-mail to otisrep@aol.com.

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