Statistically, roughly 80% of all small businesses will fail due to cash flow challenges. And sadly, most of the time these closures could've been avoided, with the right plan in place. Many small business owners seem to feel that cash flow forecasting is only for businesses in a cash crisis. Well, nothing could be further from the truth. This is one of the reasons so many small business owners wind up in a cash crunch.
A cash flow forecast can be a valuable growth tool, allowing you to make sure you have the right amount of money at the right time. Forecasting your cash can help you anticipate cash gaps and surpluses well in advance. Too many small business owners confuse profit with cash flow. Even a profitable business can be forced to close its doors if it runs out of cash. But a solid cash flow forecast can help avoid that, and let you know in advance when cash will be low so you can take steps to keep from running out. It can also help you find ways to maximize how much use you can get out of your cash. Here’s why every business needs cash flow forecasting.
Notice cash shortages
A robust cash flow forecast can help you spot cash gaps far in advance, allowing you to take action. This means that you can negotiate better loan rates, tighten up your credit control systems, and manage expectations with your suppliers.
Forewarned is forearmed and being aware of impending cash shortages can mean the difference between saving your business and waiting for insolvency. A cash gap may mean that you have to apply for funding.
Use a cash surplus to grow
For growing businesses it’s important to notice, and take advantage of, a cash surplus. With cash in the bank you have the opportunity to invest your money and grow your business. Seeing a healthy figure in your bank may be great but dust is the wrong thing you want your cash to be accumulating.
Cash flow forecasting enables you to know exactly how much you can reinvest in your business and when. By including a cash flow forecast in your financial management systems you can ensure that your business grows at a safe and healthy pace.
Tracking Your Spending
A cash flow forecast spreadsheet puts these together, breaking down incoming and outgoing cash by week, month, or quarter. A simple forecast would have entries showing cash on hand at the beginning of the period, expected expenses during the period, as well as expected receipts during the period. If the total at the bottom of any period's column is negative, a cash flow crunch may loom and action should be taken to avoid running out.
Many businesses have lines of credit to help with recurring cash shortages, and a one-time shortfall can be filled by taking out a loan. But, ideally, your cash flow should be managed to avoid these shortfalls and reduce borrowing costs in the long term.
Gain confidence in your financial systems
Profitability doesn’t necessarily mean that your business will grow, or that you have cash in the bank. A profit and loss sheet will only tell you part of the story. Without a strong grasp on your available cash, you’re not getting a true picture of your business’s finances.
Determine your break even point
You should know when your business will become profitable, not because it will affect your cash flow, because it won’t, but because it gives you an early goal to strive for and a ready-made target for projecting future cash flow. Negative cash flow and negative profits make for a grim combination. Focus your efforts on managing your cash flow with an eye toward reaching that moment when you realize your first profits.
Focus on cash management, not profits
Use your break even point as a benchmark. After you reach break even and your business is profitable, you still need to manage your cash flow, of course. You have reached another stage of your business’s life.
Cash flow forecasting can show you where you need to tighten payment terms, cut operating expenses, or hire new staff to carry the workload. Seeing the minutiae of how your cash actually moves in and out of your business can help you to identify areas in which you can improve cash inflows and outflows.
Regular cash flow forecasting is an essential part of business planning. It can make you aware of changes to your finances before you hit crisis point. Improving your awareness of how and when money is moving in and out of your business strengthens your ability to make the right decisions at the right time.
BONUS!! Here’s 4 Simple Tips to Managing Small Business Cash Flow
Assess Your Fixed Expenses - Fixed assets are typically the easiest to manage. This includes items like loan repayments, rental fees, and insurance, which are typically due on specific days of the month. The important thing to manage here are the dates on which these items are due. Try to put some distance between the dates on which you receive funds from invoices and customer payments, and the dates on which you make your fixed payments each month. With enough days separating the two events, you may be able to bank your cash and create a small bit of revenue from interest depending on your account. Every little bit counts, and creating an internal system like this in the early days of your business can pay off later. As you grow, that small revenue bump may grow, too.
Estimate Variable Expenses - While some bills will always fluctuate from month to month, it is possible to determine a reasonable, educated range of your expenditures. For instance, the power company may be able to help you determine a close estimate of your monthly electric bill. When you are making these estimates, be sure to use the higher numbers; it is almost always better to estimate that an expense will be higher, rather than lower. Whatever is left over can be placed in reserve for an end-of-year bonus, a capital investment, or to help grow the business.
Regulate Customer Payments - If you offer some sort of payment plan for your customers, or if they have recurring fees such as membership dues, take stock of when these payments are due. If possible, sign up your customers on an automatic debit system so that you don’t have to worry about them forgetting any payments. It can also be beneficial for some of your customers, as they won’t have to worry about an account lapse.
Invoice Early - Keep strict records of your work, and make sure that you send an invoice to your customer as soon as the job is done. The more you delay, the longer it tends to take clients to pay. Send an invoice via e-mail the very day you are finished, and then consider following up with a paper copy. With an e-mail, you will have a time-stamped record of the invoice. It may be worthwhile to investigate online payment systems as well, which allow you to send an invoice through their website, and then receive an electronic transfer. Be aware that some of these services will take a percentage for handling the transaction, and that will affect your cash flow.
Simple adjustments can make a huge impact.