One of the best books that business owners should read is “Simple Numbers, Straight Talk, Big Profits!” by Greg Crabtree, CPA. In the book, he outlines the Four Forces of Cash Flow. This is a great cash flow model that can apply to almost any company. These Four Forces are the foundational elements for financial stability and growth.
So, what are the Four Forces of Cash Flow? Let’s break each one down in detail:
One of your top priorities as a business owner is to make sure your tax liabilities are covered. It’s important to set aside enough cash in order to make your quarterly estimated tax payments. The goal is to have zero tax liability at year’s end. Planning for your tax payments and optimizing your business tax strategy overall will help you improve your after-tax profit potential. The key here is “after-tax.” Make sure your taxes are taken care of so that any profit you earn is truly profit.
Another important cash flow goal is to eliminate your short-term debts by the end of each fiscal quarter. Long-term debts are a different story as you want to remain current on those payments, but short-term debts should be exactly that—short-term! Don’t let them linger too long and hinder your cash flow from one quarter to the next. Minimize your overall interest payments and do your best to eliminate these smaller debts from your books. Work to pay down your lines of credit and avoid building up unnecessary debts to help optimize your cash flow.
Assuming you have your taxes and short-term debts paid off each quarter, it’s smart to build in a cash reserve that allows you to stay fully capitalized. In the book, Crabtree recommends a core capital target of two months’ worth of operating expenses. These should be tucked away in a specific core capital account that ideally shouldn’t ever be touched. To calculate this target amount, you will determine your monthly operating expenses and subtract average cost of goods sold.
Lastly, you can improve cash flow control by paying periodic dividends to shareholders and distributing bonuses to your top-performing team members. Build in these dividends and distributions as part of your quarterly and annual cash flow budgets so they are not excess expenses that negatively impact your cash flow requirements.
The key to the Four Forces of Cash Flow model is to carefully manage your cash flow and plan for certain expenses like taxes, debts, core capital and dividends/bonuses. Having these items built into your cash flow model will help ensure your needs are always covered and you have consistent cash reserves at all times. Don’t let cash flow become a roller coaster ride from month to month and quarter to quarter. Keep it under control and your business will thrive!
For more help with cash flow planning and management—along with other business and tax planning services—contact Illumination Wealth today to schedule a no-obligation introductory consultation with one of our leading advisors.