Why you should do Cash Flow Forecasts

Cash flow is still a stumbling block for most small businesses.

It is an ongoing bad dream that keeps their owners awake at night.  Before you can improve your cash flow you first have to manage it.  Cash is the lifeblood of any business.  Run out of cash and you are out of business, no matter what your accounts are telling you about profitability. 

If you can’t pay your bills your suppliers won’t want to know you, and how long will you keep staff if they are not being paid?

Managing your cash flow means knowing, and controlling exactly how much money is going in, and out, of your business.  It guides your decision making.

The buck stops with you!

So often I have heard “Oh, my accountant looks after everything when it comes to money!”  Not so.  The reality is you are the one signing the cheques.  You are the one who must make the decision on which bills to pay, and when, or to purchase more stock or equipment.  Your accountant concentrates on the taxes, ensuring you are in the clear with all matters compliance.  Hopefully you will get to the stage where you can employ at least a bookkeeper or internal accountant, but until then – it is you.

So it is critical to understand how cash flows in and out of your business and the impact poor cash flow management can have.  If you are to stay afloat in difficult times, and haven’t we seen some of those, cash flow must be managed.  Poor cash flow management can make or break your business.

Good cash flow may happen accidently, but it is far better not to leave this to chance.  Good cash flow means you have sufficient cash reserves to pay your suppliers, staff and any financiers (banks, leases hire purchase etc.) and not just from the revenue from that week or month’s sales.  I’ve been down that path and it is not nice.

Are you managing cash flow, but not profitability – or vice versa?

Here are four issues to consider:

1.    Do you know the difference between profit and cash flow?

As you will no doubt have discovered profit and cash flow are two very different things.  Nett profit is what is left after all expenses have been deducted from your revenue.  It is profit that pays back your debt and funds your growth.

The usual way for financial transactions to be recorded is on an accrual basis; that is, the transaction is recorded when it actually occurs, not when the payment is received or made.  That time difference can be significant.

On the other hand, cash flow is the money actually moving into the business, from sales, debtors and disposal of assets, and out of the business in expenses, repayments and equipment purchases (the latter depending on how the purchase is funded).  It is recorded when it actually occurs.

This leads to the common situation of your financial statements showing a profit, but not having the money to pay suppliers.  Your money is tied up in the Working Capital Wheel  (inventory, debtors and Work in Progress).  Poor management can clog that wheel, dragging you into a cash flow nightmare.

2.    Do you understand when you introduce costs into your business you are eroding your margins, unless you can also increase your prices?

Sometimes people believe costs can be absorbed in their business, and this is right to a certain extent.  However, unless you can increase your prices, additional costs reduce your margins, no matter whether the cost is a Variable Cost (i.e. a Cost of Sales), or a Fixed Cost (i.e. Overhead/Administrative costs).   

That margin is your profit, and while the actual cash into the business from a sale may be delayed, depending on your Payment Terms, it is immutable that the lower your margin, the tighter your cash position will be.

3.    Did you do a cash flow forecast when you went into business to determine how much money you would need?

New businesses usually don’t generate instant income at the level they need to survive.  It takes a while to build up.  But usually the overhead expenses are there, lying in wait as it were, ready to mug the unsuspecting owner. 

Depending on the assumptions you make it should give you a clue as to how much cash your will need to fund the business, and when.  That enables you to plan ahead and seek the funding you may need.  Your bank will be less than impressed if you suddenly arrive on their doorstep seeking emergency funding.  On the other hand, a well-prepared cash flow forecast will put them in a much more equitable frame of mind.

4.    Do you do cash flow forecasts now; for the next three, six, and twelve months?

The same principle applies when your business is up and running, even when it has been running for some years. Then you will have the advantage of experience and records to more accurately project your likely cash position over the period ahead.

Cash flow forecasts are also useful for evaluating investment decisions or major projects.  Back in my aerospace industry days, before submitting quotations for major projects I was always required to do monthly cash flow projections over the life of the project to inform the Board when the project would become cash flow positive, and what & when would be the maximum funding requirement.

It also enables you to evaluate changes in business conditions.  For example Dun & Bradstreet’s latest Trade Payments Analysis survey found in the last quarter of 2013, only 46% of invoices were paid within a standard 30 day period.  The average time to pay invoices was 53 days.

They expect payment times to remain slow for the first quarter of 2014.  While businesses were battling with receiving late payments, 49% confessed they would miss payments to suppliers if they did not have enough money at the time.

Don’t stumble into a cash flow nightmare.  Managing your cash is different from being profitable.  Properly managing your cash can be the difference between success and failure.

To your profitability and a cash flow nirvana!

© Copyright 2014 Adam Gordon, The Profits Leak Detective

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