What is the biggest worry that keeps small business owners awake at night?  More than likely, it’s the fear of having little or no cash flow to pay bills and make payroll.  After all, if there isn’t anything in the bank, it is nearly impossible to keep the business operating.


Most of the smaller business owners I know, tend to look at their check books and see if they money in there.  If they do, it is a good thing and if they don’t it creates a lot of stress. As the business grows using this simplistic system will get the business owner in trouble and depending on the seasonality of the business and the rate of growth, it can create a very big problem.
 

Here is how to develop a cash flow forecast.

  • Review your financial statements.  Review your financial statements for the last 12 months; see where your money is being spent and when it is being spent.  For example, contents insurance may be $10,000 for the year, but most of the cost may occur in 8 months of the year, make sure you know which 8 months.  You need to review every line item and get a feel for how your expenses flow, this is critical to good cash flow planning.  While you are doing this, you might do a self check and see if the expenses seem reasonable for each line item.  If not check it out, there may be some expenses improperly allocated or in the wrong G/L number or some body paid for something they shouldn’t have purchased.  It is a good gut check to see where all of your money is going.
  • After reviewing your historic expenditures, do an expense budget for the next 6 to 12 months, identifying everything you can on what you will spend money for.  This should be in two parts, expenses for your cost of goods and then your overhead accounts.  Normally if you use a percentage of sales for cost of goods cost allocation, it should be pretty close, if you cannot actually calculate the projected cost from your revenue accounts.
  • Then develop realistic sales goals by month by product line.  Look for any wide change in revenue levels or seasonality and make sure you follow that same trend into the new year.  If your financial statements don’t do a good job of breaking out revenue by distinct sources, talk to your controller, bookkeeper or accountant about getting the correct information into the right categories into the statements.  Many times, financial statements are created for the benefit of calculating taxes and not for the benefit of managing the company.  Get that changed so you can track your revenue drivers. Use your last year’s month by month revenue numbers to help you develop revenue for the forecasted period.  Then talk to the owner, and sales staff to see if any new product or service is coming out that will impact revenue.  You not only need to account for the revenue but also the cost of goods.   

  • Your net result will be a 12 month forecast that will define your revenue, your cost of goods, your over head, interest costs and your profit.  If the company is not showing adequate profit, go back and go through the process again until the company can be operate profitability. Profit is one of the cash drivers.

Now it is time to predict your cash flow.  If your business operates on a cash and carry basis, you can chart cash flow with ease because most of your revenues are collected in the month that your sales are made.  If you finance your customer for 30 to 60 days at a time, predicting the cash flow is a little more difficult but not impossible.  You have your expense pretty much defined in the month which they are paid, now you need to predict which month your revenue will be collected for the year.  For example, if you sell $100k worth of product to Joe in January and you give him 60 days to pay, you will collect that money in March.  Normally, you can look at the historic collection cycle and get a little better idea on a gross basis.  Another method is to use the historic average collection days by month; but either way works well.

This process works the same way when you are paying for product that you are given time to pay for.  For example, you purchase steel and you have 45 days to pay, the purchases you made on January 20, are not due until March 5 and you don’t have to schedule that payment into your cash expenditures until March although you made the purchase in January, you don’t have to pay for it in January.

By using a spread sheet for your cash flow forecast, you can tell if your cash will be positive or negative at the end of each month.  If it is negative, figure out what to hold up payments on until cash will be positive.

With a cash flow forecast, you can do a pretty good job of predicting your cash needs, your future cash balances and your peace of mind.  It is always more comforting to have a couple of months working capital in the bank than not knowing how much cash you have or if you will make it through the next week.

The very best way to safe guard against losing sleep at night and making sure you have enough cash to run, operate and grow your business is to implement a forward looking, cash flow predication system.   With this system, you can actually foresee the future uses and sources of cash and do something about it if you see a shortage a few weeks or months in advance. A few years ago I was working with a company that was growing very rapidly and management notified me that a new product release was going to be 3 days late.  Plugging this information into the cash flow forecast, it told me that in the sixty days, the company was going to be $500,000 short in cash.  Three days doesn’t seem like much, but if it is at the end of the month and you are paid 30 days after month end, delaying that release into the next month was going to be big problem.  Without a cash flow forecast we would have never been able to know that we had to pull out all the stops and make the product ship on time.

 

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