Cash Flow Part 1: Important Finance Lessons I Learned Playing MonopolyJonathan Ankney
I moved to New York shortly after graduate school, and spent the first few years living with the obligatory cadre of roommates. One afternoon we, along with another college friend, engaged in a game of Monopoly©. I remember this game well for three reasons: first, because I won it, and second, because the other three players formed a consortium to try to defeat me.
But the third reason I recall the game is the subject of this column. As the game played out with lucky rolls in my favor, I ended up with a number of high value properties, was “profitable”, and ended up spending nearly all my money purchasing hotels. As a result, my Monopoly balance sheet was strong—all assets, no liabilities, but I was short on cash. Further, the roommate / college chum conglomerate was furiously conspiring against me by pooling their resources together to put hotels on their respective properties. One bad roll of the dice, and I would need to start selling hotels at a loss and stop collecting rent on mortgaged properties, potentially putting me on a downward cycle that could have even cost me the game. Since then, I have regularly recalled the two lessons of that game: 1) use cash profit to reinvest in your business, and 2) it is possible to go bankrupt simply because the bank account itself is dry.
Cash management is exceptionally important for businesses of all sizes, and the ability to reasonably predict cash needs, take charge of the treasury, accumulate a comfortable reserve, and have enough money for business investment are key to creating the business and entrepreneurial life that we seek. How we predict cash is the subject of today’s column, and we’ll explore other aspects in future columns.
The Cash Flow Formula
The great news is that the formula for figuring out how much money you will have in the future is actually quite easy:
- The starting bank balance,
- Plus expected receipts,
- Minus anticipated expenses,
- Equals the future bank balance.
So if I want to know how much I’ll have in my bank a month from now, I’ll look at the starting balance, review my receivables and estimate when clients will pay, see if there are any additional invoices I can send out, and then list the payments that I’ll need to make. I could even take it further and estimate how much I’ll need in three months. In this case, I could repeat the process three times, in which case the ending balance of one month becomes the beginning balance of the next month. Here is an ultra-simplified example:
Applying the Cash Flow Formula
The first tricky part can be the bank balance itself. One of my friends told me he looks at his bank account on line. That’s fine if a business pays all of its bills electronically. But if there are paper checks that haven’t cleared yet, then it could be a problem. In that case, either go to your accounting program to get the balance, or use the bank balance and then adjust for undeposited money and outstanding checks like this:
Cash outflows are typically predictable. There are surprises, but a business owner should know what the monthly needs are, and then figure in an additional amount as a buffer for surprises. But it’s the inflows that can be most difficult to predict, because sales and collections are subject to a myriad of factors: the economy, seasonality, and customer tastes are key variables affecting on when money might come in. I find that it is both a science and art: the science comes from reviewing past trends—knowing what previous sales cycles were like, which clients pay faster or later, and watching economic trends. And the art? That’s one’s personal sense and intuition about what the numbers will mean.
So these are the fundamentals of forecasting your cash. Be on the lookout for the next Smart Hustle finance column, where we’ll look at simple and effective techniques for controlling cash.