How to make financial decisions based on what’s Actual, Pending, and Possible.
As a business owner, consultant, or freelancer, I bet you’ve said something along these lines within the last seven days:
“I have $x in the bank and $y in outstanding invoices/payments due to me. If I could just generate another $z per month, everything would be fine.”
Without realizing it, you were using the APP framework to think about your money.
- Actual represents the cash on hand.
- Pending represents payments owed to you and by you.
- Possible represents your best guess at future income and expenses.
Most business owners mush all three types of money together when making financial decisions. This is a disaster.
- Your entrepreneurial optimism drives forecasted income up and forecasted expenses down.
- You make spending decisions today based on your fuzzy, optimistic forecast.
- Your fuzzy, optimistic forecast doesn’t come true, so you end up with a cash crunch and/or credit card balance.
Does that mean you shouldn’t forecast? No; forecasting is essential to financial health and growth in a business. The key is each money type to its best use:
- Use Actual and Pending cash to make spending decisions.
- Use Possible cash to inspire revenue creation and cost-cutting.
Zero-based budgeting (or envelope budgeting, as it’s often called) asks you to:
- Maintain high awareness of your cash on hand.
- Allocate every dollar of available cash to a specific spending category in your business.
- Stop when every available dollar is spoken for.
Zero-based budgeting forces you to acknowledge how every expense in your business competes with every other expense for your money. Acknowledging scarcity improves decision-making because it quantifies trade-offs: I’m spending on this instead of that.
If I use a credit card and an optimistic forecast to spend on this and that, I’ve skipped the crucial step of asking how, when, and if this or that is likely to really benefit the business.
That’s how we end up with credit card debt and reduced owner income. No judgment – we’ve all been there.
Pending cash can also help you make spending decisions — if you keep it in the right context. You can trust Actual cash 100% because it’s already in your bank account. Depending on your business, your payment terms, and your client reliability, Pending cash might carry a 50% probability or a 95% probability. Factor it into your spending plan accordingly.
What about Possible cash?
You don’t want to factor Possible cash in today’s spending decisions. That’s how you end up saying crazy things like “Sure, we can hire that new team member! According to our forecast we’re going to double revenue by next Thursday!”
Your forecast’s job is to inspire you to take your business to another level. How? With if/then statements based on your Actual and Pending data:
“If I increase revenue 2% per month, I’ll be able to give myself a $1,000 per month raise starting in December.”
“If we can shave $500 per month off our software budget, we can shift that money into sponsorships.”
Without your Actual data, your Possible data wouldn’t mean anything. But because you can trust your Actual, your Possible will be realistic and useful (and actually inspire you to action).
Use APP to make money decisions in your business:
- Actual cash pays today’s bills.
- Pending cash tells you which spending you can put off until later.
- Possible cash inspires you to cut spending and build revenue.
I hope that’s helpful.