Cash is the lifeblood of any business, particularly for small enterprises and high growth start-ups. It’s easy to get hung up on profit but there’s great danger of business owners not putting enough focus on cash flow.
Having accurate cash flow forecasts in place can help you foresee potential problems which may arise in the months ahead and it can help businesses make important decisions about their future on what they can and cannot spend money on.
Where to Begin
Cash flow forecasts typically start with projecting sales, sales for which payment is likely to have been received, not just invoiced. Recognise the difference between the two here if your business makes sales on credit because the time between a sale and collecting the cash can widen quickly when times get tough. We would like to have a dollar for every time we have heard “business would be fine if only I could get my customers to pay on time!”.
Prior year figures are typically the starting point for forecasting monthly and quarterly sales. One also needs to take into account any seasonal patterns and build in current trends and market conditions to help with consistency. Include an estimate of the cash flow impact of any future promotion events you have planned such as advertising campaigns, trade shows and new product launches. Also try to include an assessment of the impact of any such actions from your competitors.
For new businesses, forecasts will need to be created from external sources and pure “guesstimates”. Industry groups, suppliers, customers and similar companies are all useful sources of information. The Australian Bureau of Statistics also has a wide range of demographic and economic data which may help estimate the size and growth.
Once you have prepared sales forecasts, calculate your operating and capex cost forecasts. Again, timing is important and relates to when you expect to pay your bills rather than when you expect to be invoiced. Do your suppliers give you the same payment latitude as you give to your customers? If not, can you take steps to reduce the average number of days it takes for customers to pay you? The cash flow forecasts will then show the expected state of your bank account at the end of each month throughout the year.
Cash Flow Planning
Cash flow planning is imperative. You need to be disciplined and regimented with knowing the amount of cash and when money is coming in and going out of your bank account. If your cash flow forecasting is robust, you will be able to deal with any challenges or issues that come your way.
Checking the details
Remember that cash flow forecasting is fairly straightforward, but a quality set of forecasts requires some serious attention to detail. Forecasts should also be constantly reappraised during the year as conditions change. We suggest that cash flow forecasts be updated at least on a quarterly basis.
The Decision Maker
Almost every business decision should be made against the background of high quality cash flow forecasts, predictions that can then be tested for different trading circumstances.
Positive operational cash flow puts cash in the bank. This leaves the business with the capacity to support spending on both operational expenses (more staffing, for example) as well as to fund lumpy items such as public relations, machinery (capex) or vehicles. Negative cash flow forecasts may lead you to reassess whether that spending is necessary now and if so it is likely to prompt pre-emptive conversations to secure one of all of the following, in order to ensure the ongoing viability of your business: (i) your bank manager on securing an overdraft, or (ii) a cash flow lender enabling you to securing upfront cash on your yet to be paid invoices (Invoice Financing), or (iii) an equity capital injection from family, friends or third party investors.
If you decide to borrow from the bank or any other lender of debt (including FinTechs), the additional interest expense charged on such a loan should be added into the cash flow forecasts. More scenario work would be a good idea before committing to such. Example: What would the additional interest expense do to my cash flows and how will it affect the growth of my business versus the headline number? If you chose to secure an Invoice Finance facility, there is no upfront interest charges to pay (as it’s not a loan), but you would need to take into account that the upfront cash you will receive will be slightly less than the face value of the invoice you have issued to your debtors (it’s like getting an early settlement discount). Again cash flow scenarios should be undertaken. An equity injection is unlikely to come with an interest coupon, but this will result in you diluting the equity value that you own of your business. Depending on the stage of growth of your business, your risk appetite and various other factors that should be taken into account, either one of these could be viable solutions for you and your business.
Actual financial results should be compared to forecasts at least quarterly if not monthly.
Need more advice?
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The Invoice Market (tim.) is committed to helping small and medium size businesses access the funds they need to grow.
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