Why you need a Cashflow Forecast
Whether you have recently started out in business or are established you may have been told at some point that cash flow issues will kill a small businesses.
There are many reports that show just how many businesses fail in their first few years simply by not paying enough attention to how the cash will flow through their business. There’s no way of sugar coating it, cash flow problems are a major factor in a startup’s demise.
What is a cash flow forecast ?
A cash flow forecast is a plan that shows how much money you expect to receive, and how much you expect to pay out, over a set length of time.
Here is why a good cash flow forecast is often the solution to avoiding money problems in your business.
1. It tells you when your business will run out of cash
All businesses know that to get up and running you have to spend money. To speculate is to accumulate they say.
It’s a vicious cycle, spend money to make money, then spend the money you make back on the business.
But how does a cash flow forecast help here?
A cash flow forecast in this instance isn’t going to solve your problem, but what it will do, is make it easier to keep track of your cash and help you predict future problems and needs.
An accurate forecast will show you how many sales you’ll need to make to break even, and when you’ll need to source more cash.
Most businesses when they start begin with loans or savings, very often from the owner and the rate at which you get through this money is essential to know.
How quickly you get through this money is crucial to understand, as it’ll help you monitor your cash.
Let’s look at two simple examples:
Gross rate = monthly spend divided by the total amount of capital the business spends every month.
Net rate = monthly loss divided by the total capital spent in the month, minus any revenue earned that month.
The period in which you’ll burn through the cash will vary from industry to industry as it can take some products or services longer to find a route to market.
2. It pays to try and be realistic with your sales forecast
When starting out in business you need to be careful not to get carried away with your sales forecast. When a business starts there is great excitement around and it is all too easy to get over optimistic about sales and when the cash will come in.
So, how does a cash flow forecast help here?
When preparing your forecast you need to temper your expectations and make sure they stay realistic. This will give you a more accurate picture of when you’ll need to source more cash.
The best way to do this is to create multiple forecasts for different scenarios. Look at what the best case would be and then create a worst case. You will probably fall somewhere in the middle.
As you can see a cash flow forecast provides you with some insight into your business’ future, allowing you to make informed decisions today, and prepare for whatever the future will throw at you.
3. It can prove you have a working business model
If you’re planning your business or thinking of changing your business model, a forecast is vital for ensuring it’ll work and will show you how to plan to go about making money.
So why is this so important?
Your chosen business model is the key to your business being profitable and sometimes a model just won’t work. For example the “pile them high, sell them cheap” model will work for only a handful of businesses.
This is why it is so important that you get the model right and without a cash flow forecast, you will essentially be guessing whether your business model is going to work long term.
The cash flow forecast will tell you if your business model will work in line with your assumptions about customers and costs.
If nothing else it gives you the opportunity of testing your model without going live and if it is unlikely to work then you can change it. There is nothing worse than launching your business or product and then having to alter things / payment terms etc straight away as the model won’t work !
How much better is it to be able to simulate the results of different business models in an afternoon rather than using a whole year only to find out that your chosen model won’t work.
4. It is even more essential if you sell goods or services on credit
Most of us don’t enter business to offer credit but it is a fact of life that we sometimes have to. So imagine that you have to give your customers 14 days to pay, that’s 14 days without any income after you have incurred all the expenses. What if this period extends over say the end of a month when you have to draw money to meet your bills or pay your staff.
Then, just as you get paid you have to ship more goods or undertake additional services and the whole cycle starts again and this always assumes that the customers pay you on time. What if 10% of them delay their payment and effectively extend their credit from 14 days to 21 or 28 days. What effect will that have on your cash position ?
You need to ensure that you can cover your cost of sales and operational costs whilst waiting for payments from customers and a cash flow forecast will help you understand when you’ll be paid and how this impacts you.
There is also the unfortunate possibility that when you sell goods and services on credit, you won’t be paid at all and these non-payments, known as bad debts can seriously impact upon your ability to trade.
So, making sure that you model the impact of credit on your cash flow is essential for working out whether it’s a payment option you should offer.
So here, in a nutshell is why every business needs a cash flow forecast
- Show you cash running out before it happens
- Prove (or otherwise) your business model
- Measure your Sales forecasts
- Help you determine what credit options, if any, you should offer
There are more reasons why a cash flow forecast is important but these are just a few and ought to be enough in themselves to mean you want to preapre a cash flow forecast now.
I know this can be a daunting thought so I’m here to offer that service to you and if I can help simply get in touch.