Whether or not you have the cash in the bank to keep your business running is one of the biggest concerns of most business owners. With good reason – a lack of funds is the number one reason why businesses fail. However, despite online accounting becoming simpler than ever, many businesses still fall into the trap of not forecasting their cash flow consistently. Here’s why cash flow forecasting is important for your business, even if you’re not experiencing cash problems right now.
1. Proactively manage cash shortages and surpluses
Forecasting your future bank balance allows you to see when you may have a cash shortage that could cripple your business by stopping you from paying your staff, your debtors or yourself – and it gives you enough time to do something about it. By identifying a cash gap well in advance and taking action you could get better loan rates or be able to tighten up your payment terms to bridge the gap. As the saying goes, forewarned is forearmed.
However, the inverse can also be a problem. While having a cash surplus is great, when you’re not doing anything with it that money is gathering dust. If you can spot in advance when you’ll have excess cash in the bank you can make plans for it. Maybe you can invest in some new equipment, buy more stock, pay dividends or take on another project. Cash flow forecasting tells you exactly how much you can afford to safely invest in – or take out of – your business. So if you want advanced notice of changes in your cash position to give you time to react appropriately, you should be forecasting your cash flow.
2. Scenario plan for future ‘what if’ questions
Are you thinking of hiring new staff? Or working out a succession plan? Or bringing on investment? Doing a cash flow forecast with different ‘what if’ scenarios helps you see the cash impact of your future plans. In any eventuality, you need to efficiently plan where your cash is going to understand whether it’s feasible.
3. Track spending and stay in budget
Having an overall idea of how much comes in and out of your business is great, but are you always right? A profit and loss or a balance sheet will give you a snapshot of what is happening right now, but it won’t show you the future in terms of the cash you will actually have. In other words, it won’t be ‘real.’ With a cash flow forecast that has been updated with actuals, you can compare your best guess to what really happened, helping you see if you need to update your forecasts.
4. Negotiate the feast and famine of project work
If the majority of your income comes from project-based work, you’re probably used to what we call ‘lumpy cash flow’. This means that cash often comes in large chunks or not at all. This ‘feast and famine’ situation will require careful planning, and building up a cash buffer to weather the dry periods. By consistently doing a cash flow forecast, you’ll be able to much more easily understand when things might get hairy, allowing you to take action sooner and more effectively.
5. Take drawings confidently
We’re guessing that you had lots of reasons for starting your own business, but one of your key drivers is probably to make more money. By doing a cash flow forecast you can maximise exactly how much you and your business partners can take in drawings while still meeting your obligations and maintaining a contingency cash buffer. Using a profit and loss to do this won’t show you the true picture of how much cash you’re actually going to have, and could lead you down a perilous path.
6. Trim operating expenses to increase gross profit
If you do a direct cash flow forecast, you’ll gain a picture of your budget vs. actuals across your entire business to understand where you have over and underspent. You may uncover surprising areas where efficiencies and cut backs can be made to increase your overall profitability.
7. Pay your suppliers on time
Whether you pay your suppliers on time and in full will affect your reputation, and may affect whether or not suppliers want to work with you. Forecasting how much cash you will have in the bank will show you whether you can afford to pay on time, or whether you need to manage expectations with suppliers. By making timely payments, your suppliers will be more likely to do you favors later on.
8. See the impact of late payers and improve credit control
By doing a direct cash flow forecast that takes into account invoices for your debtors and bills from your creditors, you’ll be more easily able to identify who is consistently paying you late, enhancing your credit control process. You could go a step further to model different payment dates on overdue invoices to see the true impact of late payments.
How do you forecast your cash?
You can either 1) ask your accountant for help creating one, 2) do it yourself in a spreadsheet using a template, or 3) use a direct cash flow forecasting tool that connects right into your accounting software like Float.
Further reading – 5 things you never knew about cash flow
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