First Step Marketing

Assembling a cash flow statement: chronicling the past. To help you get started in putting together your own cash flow statement, this section describes the cash flow statement of a hypothetical architectural firm, ABC Architectural Services.

The cash flow statement is for the four months just ended (For the purpose of the exercise, we assume that we’re now at April 30.)

A few notes about this company:

It employed seven people in January and received two new architectural design contracts in January for $25,000 each. These jobs should each take five months to complete and are payable as completed.

ABC Architectural Services added two employees at $36,000 per year in February and one employee at $24,000 in March to help on the new contracts. It added 50% more space in April. And aside from the two new contracts, business is assumed to remain level.

Now let’s see what the cash flow statement tells us. First, we see that the expenses associated with direct materials and equipment move upward. That’s because those new employees will require office supplies, like drafting materials, desks, lamps, wall dividers, maybe a computer terminal and some software. Next, the main fixed expense, which is salaries, goes up substantially in February and March.

The other side of the cash flow equation is the incoming cash—in this business and most others a function of the collection of receivables. At ABC Architectural Services, the new employees will require some training and assistance during their first month on the job, so the assumption is that it will take them two months—February and March—to do the first month’s work. Even so, the assumption is that the company collects for that entire first month of work during the month of April, so in April there’s a $10,000 jump.

The impact of the outflow and inflow just described is apparent in the cash balances. ABC Architectural Services begins with $55,000 cash on January 1, as shown in the upper left-hand corner, and by April 30 it’s down to $12,000, as shown in the lower right- hand corner. Clearly; its position is less comfortable.

An important point becomes apparent. The expenses pile up a lot faster than the revenues come in. Just because a company gets two $25,000 contracts doesn’t mean it suddenly has $50,000.

This company placed itself in a precarious financial position because it didn’t structure its contracts to allow for its small size and vulnerable cash position. If those two new clients had taken 90 days to make their first payments instead of 30 days, at the end of April the company would have been down to $2,000 cash. By May, it could have been out of business.

Assembling a cash flow statement—projecting the future. The previous section used actual financial results to gain insights into business strengths and weaknesses. But it’s possible to take those results and look into the future by doing financial projections.

Exhibit 9-3 is a projection for the next four months for ABC Architectural Services. The managers of the firm realized cash was diminishing, so they decided they had to hold the line on expenses; thus, the material expenses level off and the equipment expenses decline.

But because they’ve added 50% more space earlier in the year, they feel an obligation to make that space as attractive as possible. I would argue that these expenses, particularly materials, are probably too high. Unfortunately, they’re stuck with the salaries they brought in, unless they want to take the drastic step of laying off the new employees.

Next, the executives resolve to watch the receivables very closely, to ensure that enough cash is coming in. This is reflected in the projected collection of receivables, which continues to rise.

The effects of the planning and projections can be seen in the company’s cash position. It continues downward for May and into June, but by the end of June and July it is heading back up and, by August, it’s gotten a good deal healthier.

Monitoring the cash flow in this way should make it apparent to ABC Architectural Services‘ executives that they need to make some adjustments—in their approaches to billing and to hiring. On the billing front, for instance, the owners will likely want to negotiate fixed-fee/monthly installment contracts or regular billing with a substantial upfront payment.

If this cash flow projection were continued, another problem would become apparent: what is this company going to do to keep the three new employees busy after July when the two contracts have been completed?

Possibly related posts: (automatically generated)
Cash Flow: The Business Lifeline continue…

This entry was posted on Wednesday, February 20th, 2008 at 10:58 pm and is filed under Jobs, financial. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.