Cashflow, where does it come from? Where does it go? Sometimes, even with careful tracking and management, things can go awry. Unfortunately, in many instances, owners of small businesses tend to mix business and private transactions through the same bank accounts. Sole traders or partnerships are commonly set up without having independent bank accounts for business and personal use. Even when a formal business structure is set up such as a company, the director’s loan account is quite commonly used as the ‘slush bucket’ for private spending.
The Main Issue
Whilst there is no legal requirement that states the private transactions cannot be processed through business bank accounts, this can cause problems in the future if this is not monitored and controlled. These problems can appear in the form of increased cashflow pressure, or unforeseen taxation liabilities (in the case of a Director’s Loan in a company). In many cases, a credit card is the major culprit, with uncontrolled spending occuring quite easily. This could go unnoticed in the business, until the monthly credit card statement is received.
How to Fix it
When faced with this situation, it is important to understand how these transactions can affect the cashflow position of a business, and more importantly, try to impress upon the client how this may impact the business moving forward. If one of the partners in a business has gone on a shopping spree and put it all on the business credit card, how is this going to affect the business’ ability to pay creditors at the end of the month?
How Calxa can Help
The preparation of a Cashflow Forecast Chart and Report is an important tool that can be used to help visualise the impact of this private spending. Other Visual Charts such as the Net Worth Chart, or the Where Did My Money Go Chart also aid in getting the message across. This spending can be modelled based on prior period actuals, through the relevant Balance Sheet accounts; either equity accounts for Drawings (in the case of a sole trader or partnership) or Liability Accounts for Director’s Loans (in the case of a company). So, when preparing a Budget and Cashflow Forecast for your business or a client, we need to consider both the Profit & Loss Budget as well as the Balance Sheet Budget.
When trying to forecast values of private spending through a business, these estimates are entered on the Balance Sheet Budget as a negative value against the relevant ledger account. For example, if you were budgeting on drawing $5000 per month from the business, then this would either be entered as (negative $5,000) against the relevant liability or equity account on the Balance Sheet Budget.
Where to Start
The challenge when doing any budgeting or forecasting, is trying to predict what may happen in the future. With no controls in place, or historical trends that can be used to make assumptions, this becomes a near impossible task. So, what is the answer? Well, there is no right or wrong answer. However, keeping business transactions separate from personal transactions makes life easier on many levels. If your client or business partner is having trouble controlling their private spending, why not suggest that they limit their drawings to one withdrawal of $x dollars per month. Then put controls in place to ensure that other private spending is not done from the business account. Set up an additional credit card which is only used for business transactions.These are just a couple of examples of what can be done to help manage this leakage of cash from a business.
This will make it much easier for you to model out the impact of this personal spending on the business cashflow, if you know what it is going to be, month by month. It will also mitigate any nasty surprises that may appear on the business credit card.
Prior Preparation & Planning
Businesses usually have a lot of cash coming in and going out, and this can sometimes give people a false sense of security. Predominently with regards to what they think they can afford to spend, versus what they should (or shouldn’t) be spending. Going out and buying that $4,000 lounge suite on the business credit card because it was half price, possibly felt like a good idea at the time. But, that lounge suite may not feel so comfortable in two months time, when the BAS has been prepared, SGC payments are due, creditors payments are overdue, and there is no money left in the business bank account to meet these business obligations.
Get Started Now!
Utilising the suggestions above will assist business to improve over time. Sustainable management of finances is not something that can occur overnight. Rather a slow, purposeful change is needed to create strong financial health, starting the conversation now is the first step.