I worry most about cash flow because it’s so insidious. Like the old saying about rivers, still waters run deep. Cash is frequently hardest to manage when businesses are growing. It is the least intuitive of the financial projections, but the most important. I hope you’ve read through the cash flow traps portion of the previous section. I was trying to scare you. It’s good for you.

We got through the basic business numbers with that discussion of cash traps instead of the full detail of the cash flow. That might be enough for the early plan, but eventually you’re going to want to build a real cash plan, using real numbers, and real financial math.

Experts can be annoying. There are more than one way to do a cash flow plan. Sometimes it seems like as soon as you use one method, somebody who is supposed to know tells you you’ve done it wrong. Often that means they don’t know enough to realize that there are more than one ways to do it. You can do your

Let’s start simple here, with a basic direct cash flow plan.

A Simple Basic Cash Flow Plan

There’s nothing particularly fancy about this plan, or the table, or the math. you just need to keep track of money coming in, and money coming out. In this very simple model, your sources of money are cash sales, payments received (for sales on credit, also called accounts receivable), new loan money, and new investment. Your expenditures include buying widgets in cash, paying interest, paying bills as they come due (i.e., paying accounts payable), and paying off loans.

Even at this basic level, you can see the potential complications and the need for linking up the numbers using a computer. Your estimated receipts from accounts receivable must have a logical relationship to sales and the balance of accounts receivable. Likewise, your payments of accounts payable have to relate to the balances of payables and the costs and expenses that created the payables. Vital as this is to business survival, it is not nearly as intuitive as the sales forecast, personnel plan, or income statement. The mathematics and the financial projections are more complex.

So that last one was a simple case, but let’s take a more common case. It doesn’t have to get that complicated — remember this is planning, not accounting — but I do want to deal with some of the more important issues. So let’s create another case.

I can’t explain cash flow without income and balance. Remember, I did say that the cash flow was what brings the two together. So let me show you some samples. Here’s the hypothetical income statement:

Notice that in this case you can see how we’ve divided sales into cash sales, in the top row, and sales on credit, in the second row, and that those two rows sum to total sales. Normally we wouldn’t show that division in an income statement. I do it like this for this example, because it helps me show you what’s going on.

Now let’s look at the balance sheet. This is the starting balance for the sample case. In your own plan, you set up starting balances as part of your startup funding, or as the ending balance of your last plan. For now, here’s the example.

I’m going to use these two samples to show you how cash flow brings them together.

So let’s look then at a cash flow projection that units these two other statements. In this case we’re going to do a direct cash flow, but remember there’s also indirect, and there are experts who insist on one or the other, even though you can really do it either way.

So please follow along with me as I go through the cash flow by sections. We start at the top with things that bring in money, meaning cash received. That includes both cash from sales, and cash from other things like borrowing and new investment. You see the example here:

Cash sales is pretty obvious. It’s the same number that was on the income statement. Remember, that’s not really just coins and bills, that’s also payments by check, and by credit card. In business planning, cash means money in the bank.

Cash from receivables can be confusing at first, but what we see is the way receivables hit your cash flow. When you compare this table with that income statement we just looked at, notice what happens to cash from receivables. The $230 we get as cash from receivables in March is just about the same $228 you made in sales on credit in January. I hope you’re guessing that this is because we’re estimating 60 days on average waiting for our money. Difference between $228 and $230 is the difference between 60 days and two months. That’s a very slight difference.

So let’s look more closely at that second row, and how it’s calculated. The numbers here are in the background. They don’t show up on a standard cash flow statement, but they are critical calculations.

Remember: if you get paid immediately by your customers, by cash or credit card, you don’t have to worry as much about this. If, however, you’re selling to businesses, then this is really important. Unless you’re really unusual, with business to business sales, you deliver invoices to your business customers and you then have to wait for them to pay you. You get into a balance situation, in which they don’t want to tip the balance by waiting too long, and you don’t want to tip the balance by insisting too hard. It’s quite common.

You deal with this with assumptions. In the illustration here you’ll see an assumption for estimated collection period in days, meaning how many days, on average, do you wait to get paid. You also have assumption for sales on credit as a percent of total sales.

So that all boils down to a row in the illustration here, cash from receivables. That’s the amount that gets into your cash. You can see how this is different from sales. You can also see the flow between last month’s ending balance, this month’s sales on credit, and this month’s ending balance.

The collection days estimator sets the amounts received. (Amounts shown in thousands. Numbers may be affected by rounding.)

Just in case you have any doubt about how that works, take a look at the following illustration with the same numbers except for the change in your estimated collection days. What happens is that the more the estimated collection days, the more of your assets are in receivables, which means, ultimately, less cash. We did that in cash flow traps: every additional dollar in receivables is a dollar less in cash.

This simple change turns acceptable cash flow into cash problems.

All those other rows on the money coming in are about other ways that you might get money into your company from something other than sales. You can see the categories in the illustration to see that new borrowing, new investment, and even sales taxes collected are other ways you get money.

I don’t want to get into accounting jargon. The rest of these rows will look fairly simple to you if you’ve dealt with accounting and financial statements at all, and could be daunting if you haven’t.

Other income is there because some companies have income from special operations, like interest income, that they don’t put on their income statement. That’s very rare.

Sales tax is there because you collect tax for the government, and you have to pay it, but it isn’t really sales or income. You’re a tax collector. So you need to keep track of what you collect.

The rest is new debt, money from sale of assets, or new investment. I should add that I use “other liabilities” to keep track of debt that doesn’t have an interest rate, like loans from founders or from your rich relatives.

The total gives you all the money coming into the company. That’s the happy first half of the cash flow. Now we need to look at what we’re spending.

What I’m showing here in the illustration might look like it’s a self-contained table, but it’s really just the bottom half. This is where the money goes (or technically, where you plan to send it). The top half, in the previous pages, was where the money was coming from.

It starts with money you get from operations. That’s what you spend in cash, and what you spend to pay bills. These, between them, are the universe of things that happened on the income statement. The split between cash and payment of bills can be confusing, but we have to keep track of that to do a real cash flow.

And, just to make that even more fun, bill payment has to include payment for inventory, which is particularly tricky because inventory isn’t directly on the cash flow. As we discussed in cash traps, inventory is money spent on assets first, and those assets become cost of goods sold when they are in fact sold. We’ll look at that in a few pages, so bear with me.

Much like with the money received and accounts receivable, the first two rows of this table show money spent in cash and bill payments. Money spent in cash is frequently payroll, for example, for which you pay people directly, not after a few weeks. Sometimes there are other cash payments, such as petty cash.

The second obvious use of cash is “Bill Payment.” This accounts payable balance is money you owe. Every month, you pay off most of this, depending on how quickly you pay. As with receivables, there are some calculations in the background, like those shown in the illustration below:

In the example here, the calculations start with the ending balance of accounts payable from the previous month, then add new obligations, then subtract obligations paid directly in cash, as well as this month’s bill payments, to calculate this month’s ending balance. This month’s bill payments depend on the assumption of waiting 30 days, on average, before paying bills.

So aside from the cash payments and bill payments, the spending half of the cash flow has a list of some other ways that companies spend their money — ways that aren’t on the income statement, which is why they have to get into the cash flow and affect the balance sheet.

The list is similar to the list we have of non-income-statement money received. Just as you can receive money from other income like interest or such, you can also pay money that way. Then there are taxes, like sales taxes, which have to be paid to the government. You collected them from customers, but you have to pay them as well.

Debt repayment can be important because it’s easy to forget. The interest portion of your payments belongs in the income statement because interest reduces taxable income. It’s deductible. Principal repayment, however, doesn’t show up on the income statement and isn’t deductible. But it does reduce your cash, so you have to plan for it. Also, it reduces the debt balance, so this calculation affects your balance sheet.

In the third row from the bottom, you record the purchase of new Other Current Assets. You’ll have to know how much you purchase in new assets in order to estimate your Balance Sheet. While in real life these might also be recorded as Accounts Payable and paid a few weeks later, we make them explicit here as if they were paid immediately in cash. That makes for better cash planning.

Logically, this next row is one for purchases of new Long-term Assets. These also reduce cash.

The last row in spending tracks dividends. Dividends are the distribution of profits to owners and investors. They reduce cash but don’t appear anywhere else.

As we saw in the graphics in the cash flow traps, inventory (sometimes called stock) can have a major impact on cash flow. So we have to plan for it.

The illustration here shows one way — and there are lots of others — to plan for inventory. You have an idea how much inventory (by value, dollar amount) you would use to match your sales forecast. Then you assume how much inventory (in months) you need to keep in hand, and what the minimum purchase is. You can then calculate the details, as shown.

Inventory goes into the books as an asset when it’s purchased. It leaves the company as cost of goods sold when it’s sold. The cost of inventory shows up in the cash flow when it’s paid for, regardless of when it’s sold, usually as cash spending or bill payments.

Inventory gets into your cash flow when you pay for it. In the example here, the beginning inventory balance supplies the amounts required until the third month, when additional inventory is purchased. That purchase goes into accounts payable, and is paid as part of the normal flow of bill payments. Inventory purchase is the bulk of the $346,000 new obligations in March shown in the spending details sample on the previous page.

So now you’ve done both halves of the equation, money coming in and money going back out, so you can put those two halves together to calculate the cash flow, and the cash balance. Cash flow is the change in the cash balance from month to month. You get that by adding money received and subtracting money spent. Cash balance is the amount of money on hand. You get that by taking the previous month’s cash balance and adding this month’s cash flow to it — which means subtracting if the cash flow is negative.

Having a negative cash flow every so often, for a month, isn’t a big problem. You should never have a negative cash balance. That’s the same as bouncing checks.

I mentioned earlier that there are at least two standard ways to calculate cash. I also warned you that when you do it one way, either of the two ways, you will still encounter the occasional expert who says it’s wrong because that expert only knows one way. I’ve run into people who start looking at a cash flow by looking for where depreciation is added back to net income.

When they do that, they are using the other method, the indirect method, instead of the direct method. The indirect method starts with net income and then adjusts for depreciation and amortization (because they are an expense but involve no cash) and other balance sheet events. You can see an example here.

Results should be the same, with either method. These are just different ways to get to the same end results.

So there is no right way to do this. I used to use the indirect method in software and spreadsheets because it involved fewer rows and therefore more powerful assumptions. I switched to the direct method a few years ago because it is easier for outside readers to follow and understand. Recently I’ve taken to calculating both, using the one to check for errors in the other. If they don’t match, then there is something wrong.