Cash-Flow Projections and Break-Even

• Timing of receipts. A sale made on credit counts as revenue now, but the cash arrives later, when the customer pays.
• Timing of payments. Inventory is often bought and paid for months before it is sold. Ava paid for her first stock of bikes before she opened.
• Non-cash expenses. Tool wear (amortization) reduces profit, but no cash leaves the business for it.
• Cash that is not an expense. Repaying the principal of a loan and the owner's drawings take cash out but are not expenses, so they do not reduce profit.
• Seasonality. Sales rise and fall with the seasons. A bike shop is busy in June and July and quiet in October, but rent is the same every month.

Cash vs Profit | What's the Difference?

1. Opening cash: the cash on hand at the start of the month. For the first month it is the cash left after start-up spending; after that it is last month's closing cash.
2. Cash receipts: all cash coming in during the month: cash sales, collections from customers, loans received, owner's investment.
3. Cash payments: all cash going out: inventory and parts, rent, wages, advertising, loan payments, owner's drawings.
4. Net cash flow $=$ total receipts $-$ total payments. It can be negative.
5. Closing cash $=$ opening cash $+$ net cash flow. Carry it forward as next month's opening cash.

Ava's Cycle Works opens on May 1 with $2,700 in the bank: its operating reserve, since the other $6,000 of start-up capital was spent in April. Ava forecasts tune-ups of 30, 40, 45, 40, 25 and 15 from May to October at $60 each, and refurbished bike sales of 4, 6, 6, 5, 3 and 2 at $250 each. Every sale is paid on the spot. Her helper is paid $800 a month in June, July and August. Loan payments are $140 a month on the youth loan, plus a $1,500 repayment to her family in October. Ava takes drawings only from July to September, once cash has built up.

A cash shortfall is any month where closing cash falls below zero, or below the minimum cushion the owner wants to keep. Notice that October's net cash flow is negative (the family loan repayment is due) but closing cash stays positive, so October is not a shortfall. A negative net cash flow is a warning sign; a negative closing balance is the problem. When a projection shows a shortfall, the owner has time to act. Common fixes are:

• Delay or shrink a large purchase, or spread it over several months.
• Ask the supplier for trade credit, such as net 30 (pay within 30 days), so the payment moves into a busier month.
• Arrange a line of credit with a bank before it is needed, and repay it when cash comes back.
• Bring cash in sooner: take deposits on refurbished bikes, run an early-season tune-up promotion.
• Cut or postpone the owner's drawings, or keep a bigger operating reserve.

The cash-flow projection shows whether Ava can pay her bills; break-even analysis shows how much she must sell before she makes any profit at all. Fixed costs stay the same no matter how many tune-ups she does: in a summer month, rent, phone, advertising and utilities of $900 plus her helper's $800, for $1,700. Variable costs rise with each unit: $15 of parts per tune-up. Each $60 tune-up therefore leaves a contribution margin of $45 to pay the fixed costs; once those are covered, every extra $45 is profit.

To plan for a target profit, treat the profit like one more fixed cost that the contribution margins must cover: units needed $=\frac{\text{fixed costs}+\text{target profit}}{\text{contribution margin}}\text{,}$ again rounded up. Ava's July projection of 45 tune-ups is above the 38 needed to break even, which is evidence that her summer goals are realistic.

Break even analysis