As I promised, this week I am going to be sharing with you a very powerful cash flow chart. WATCH NOW
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VIDEO SUMMARY
To recap what we talked about last week, every business is a cash flow machine. You have cash in and cash out. To be more specific, you want more cash coming in, then going out. If you are spending more cash then you are making, your business is going to die.
When you are looking at cash flow, you really want to determine two different things:
- Are you going to run out of cash?
- The effectiveness of the business
I want to share a practical example using Excel. Now I am going to show you how to do this example with your own personal finances. So it does not matter what your situation is, anybody can make this chart. This is an easy example. This is something you can do on your own in 30 minutes. Once you understand these basic cash flow concepts, you can take this example and do it in your business as well.
Let us start by talking about bank accounts. Most people have two different bank accounts:
- Checking account – operational
- Savings account – discretionary
Now of course people have credit cards, investment accounts, and all kinds of different accounts. But my point is that no matter how you manage your finances, you have some account that is your main account for day to day expenses (which is your operational account), and then another account to move money to for savings or investments.
This is what we call living beneath your means. You have more cash coming in than what you need to live on, so you have extra every month to use for savings or other discretionary purchases. This is what a healthy financial life looks like. If your expenses are the same as what you are making or if your expenses are more than you are making, you need to make whatever life decisions are necessary to start living beneath your means. If you do not change, you will likely live through significant financial pain. As we go through this example, it will become crystal clear why living beneath your means is so important.
We have been talking about personal bank accounts, but businesses function in the same way. You have one main operational account, and then other bank accounts for other discretionary purposes. Some examples include:
- Operational account
- Savings
- Investing
- Donations
- Capital improvements
- Dividend payments
- Employee bonuses
- etc
For this example we are just going to look at a personal checking and savings account, but keep in mind that this applies to your business as well.
Let us look at a simple excel spreadsheet you can create. There are five columns:
- Week ending
- Starting Bank Account
- Inflows
- Outflows
- Ending Bank Account
You do not have to do a lot of work here. You can just take your bank statement from your checking account and put it in this format. I have this populated with dummy numbers for this example. Your numbers will probably vary significantly. But there are some important assumptions here.
If we look at inflows (or cash received) this is a person that is getting a regular bi-weekly paycheck. Obviously this person makes an enormous amount of money. This is going to be someone who makes around $200k per year. Outflows is money moving out of the checking account, either from weekly expenses or from transfers to savings.
If we look at the starting bank account number, it is $5,000. If we look at this column we see this is someone who likes to keep their bank account steady at around $5,000. That represents the amount of money they feel comfortable sitting in the bank to deal with any daily expenses that might come up. You will notice that the starting bank account amount is the ending bank account amount from the previous week. The formula for the Ending Bank Account amount is Starting Bank Account plus Inflows minus Outflows.
You look at the ending bank account column to answer the question, “are you running out of money?” If you notice a trend with your bank account moving towards zero, you need to make adjustments to correct your cash flow. In this example, it appears stable, and if we project it out into future weeks, you are not likely to run out of money. We could just end the analysis here, but we really have not answered the second question, “what is the effectiveness?” For that we need to look a little closer.
There is another assumption here, that this person needs $1,150 for regular weekly expenses. If we put this in annual terms.
This person expects:
- $195k/yr cash inflow
- $59.8k/yr cash outflow
- $135.2k/yr cash savings
This would be an enormous unusual savings rate, but we are just using this for the example. You have to remember, that financial numbers reflect people. This example is of a very frugal person. This is someone who makes an enormous amount of money, but chooses to live below their means in order to maintain a high savings rate.
We are starting to get a better understanding of this person’s financial situation, but let us look even closer. We can start by splitting the outflows into two different categories, like we discussed last week.
- Discretionary
- Non-discretionary
Non-discretionary is going to be those purchases where you do not have a choice. You need to buy food, rent, gas, electricity, internet, phone, car payment, etc. These are going to be your every day expenses. We already discussed these were $1,150/wk. Anything above this amount, this person is transferring to their savings and investment accounts, to keep their checking account balance at $5,000 as their savings account grows.
To see this, we can add two more columns:
- Regular expenses (non-discretionary)
- Savings (discretionary)
You can see that every two weeks, this person is saving or investing $5,200. In this chart, we are looking at the last 14 weeks, and we see the total savings is $36,400 (which is very impressive).
You really have to understand what the savings column means. This column is you funding your dreams. This is you putting aside money to buy a house, fund your retirement, save for a dream vacation, or a dream car, or have emergency funds, or start your own business, or have passive income from your investments. So by managing your regular expenses, you are increasing your choices in life.
This is still just a table of numbers. Sometimes it is hard to look at a bunch of numbers on a spreadsheet and really understand what they mean. For something like looking at cash flow, charts can be very helpful. I promised we would get to a chart, and we are getting to it right now. But to create the chart we need two more columns. We want to look at the number cumulatively instead of weekly. We want to look at:
- Cumulative Inflows
- Cumulative Regular Expenses
This allows you to tell where you stand at any point during the fourteen weeks in this table. So looking halfway through the period at week seven, you have brought in $22,500 in cash, and have spent $8,050 in regular expenses. By the end of the 14 weeks, you have brought in $52,500 in cash, and have spent $16,100 in regular expenses. You will notice that the total inflows and total expenses will equal the final cumulative values. And if you take your final cumulative inflows minus your final cumulative regular expenses you will get the total amount you moved to savings of $36,400.
What you want to do next, is take your two cumulative columns and turn them into a line chart. It shows the Cumulative inflows in blue, and the Cumulative regular expenses in orange. You will notice that the inflows only increase every two weeks with the bi-weekly paycheck, and the expenses are straightline because we assumed a flat weekly rate for expenses. In reality, your numbers will fluctuate, but hopefully you will see that the inflows will show a growing gap over your outflows, as you are able to move more and more money into savings over time.
The point of this chart is the gap between inflows and outflows. This gap is showing you the effectiveness.
This chart reveals three things:
- The importance of living beneath your means
- The importance of lean operations and keeping your regular expenses as low as possible.
- The importance of saving and investing in your dream life
I hope you can see how powerful this is. This is showing effectiveness. How effective are you being with your cash? In terms of a business, this gap is where you really get to show leadership. This is the money that you get to invest in your employees, and your customers, and invest back into the business, and pay dividends to your owners. The more you can control your regular operational expenses, the more flexibility you will have to run a strong healthy company.
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Neither Zach De Gregorio or Wolves and Finance shall be liable for any damages related to information in this video. It is recommended you contact a CPA in your area for business advice.