If you’re making a profit but don’t have any cash, you’re not alone. It’s a common problem faced by many entrepreneurs. Let’s look at this problem in part four of our series about creating a 2007 budget for your business.

To recap the budget process thus far:

1. Make your wish list
2. Guesstimate what your wish list will cost
3. Create your 12-month Excel budget
4. Add cash flow to your Excel budget.

So how can you be paper rich yet cash poor? The answer lies on the balance sheet.

Cash flow equals profit plus or minus changes on the balance sheet.

Mathematically, it’s that simple. Conceptually, however, it’s one of those “minute to learn, lifetime to master” concepts.Your Excel budget through step #3 is your profit and loss (P&L) projection for next year, your forecast of net income. Here in step #4 you need to add or subtract from net income material* changes that will occur on the balance sheet. By adding cash flow considerations to your P&L budget you’ll accomplish two mission critical tasks:

1. You’ll know whether your company will have sufficient working capital.
2. You’ll resolve conflicts among competing uses for cash (see End of Year Cash Flow for some common conflicts).

Here’s an example of a cash flow item that shows up only on the balance sheet, and not on the P&L: the principal portion of loan repayments. Only the interest portion of loan payments shows up on the P&L. So if you project net income of $200K next year, yet you make $24K per year in principal payments on your business loans, then your cash flow, all other things being equal, will be $200K minus $24K equals $176K.

The last piece to the puzzle is to turn your 2007 budget into a rolling cash flow forecast: enter your starting cash for the year and then watch it go up or down each month as one month’s ending cash balance rolls into the next month’s starting balance, onward through December 31st. There’s an easy, efficient way to do this that’s common to finance people, so if you don’t want to puzzle it out yourself, I can give you a quick, affordable 20 minute short-course on it – just e-mail me at the address below to schedule a virtual meeting.

* “Material” or “level of materiality” in financial-speak means “big enough to worry about”.

To learn more about the mechanics of cash flow vs. profitability, there’s lots of free information on the internet. CCH Owner’s Toolkit, for example, does a good job breaking down the math, although I don’t agree with their statement that compared to the concept of profit – “You might even say the concept of cash flow is more in line with reality!” I’d posit instead that profit and cash flow are two of three essential realities of business finance. (And the third is…???)

1. Profit and Cash Flow
2. Case Study: Profit vs. Cash Flow