We have all heard the phrase ‘Cash is King’ which is commonly used to describe the importance of cash over other forms of investments. For a business owner, cash should be seen as the blood of the business. If you run out, you will find yourself in a serious predicament. It’s no surprise that 90% of business failures are due to cash flow problems. This is something that can happen to any business, as any sequence of events could lead to a situation where there are payments due to be made but not enough cash to make them.
Now whilst running out of cash can put a business at risk of closure there is another side to cashflow issues as they can be stressful to the owner/employees of the business, impact decision making and can be costly.
Profit vs Cashflow
As profit advisors, we are a big believer in businesses having a profit approach from the start and to continue to track it but it must be differentiated from cashflow. Behind a profitable business are the ups and downs of cashflow which must be managed as part of the normal practices of running the business.
Advantages of Cashflow Forecast
Cashflow forecasting is constantly managing the cash ins and outs into the future so we know when we will have shortages or surpluses, which will allow us to plan accordingly. Here are the key advantages.
Prepare for Shortages
Knowing in advance when you are going to need to make a payment is key information which means you can plan in advance for it by eg deferring other payments where possible, renegotiating payment terms, getting additional funding etc. Arriving at that point without planning will require last minute actions which can be stressful and costly.
With surplus cash expected, you can plan on the best ways to use it eg repayment of debt, marketing, stock purchase or investment. Having this insight from the cashflow forecast will mean the chosen actions this can be planned and arranged in advance.
Track Overdue Payments
Being able to identify late paying clients and the impact to the businesses overall cashflow will drive the right decisions from discussing with the client, changing business terms or ending the business relationship.
Understand Business Spending
Keeping a finger on the pulse of the business is one of the key benefits. Knowing how much cash the business gets in and pays out, and when. This drives business decision making to smooth out unnecessary spikes and eliminate waste.
Disadvantages of Cashflow Forecast
There are some drawbacks to cashflow forecasts being the magic tool that will keep a business’s cashflow running smoothly.
How Accurate is It?
Whilst at the heart of the cashflow forecast are regular in and outs, there will be additional estimates of future activity which can end up being wrong. This risk can be managed by coming up with different outcome scenarios and creating a plan for each scenario.
Can Lead to Bad Decisions
The information from a Cashflow forecast will tell us about expected shortage or surplus which will then drive management decision making. The cashflow forecasts can lead to the wrong decisions being made if the cashflow expectations don’t materialise.
The good news is the advantages of cashflow forecast outweigh the disadvantages. Even better, the disadvantages can be managed be also looking at the impact of varied scenarios eg coming up with 3 scenarios in the planning for a particular event like Covid and producing cashflow forecasts for each of them.
How to Forecast Cashflow
As a technology focused accounting practice, cloud accounting software is key in how we operate which means very basic cashflow forecasts are easy to draw up. They can then be enhanced by working with our clients to forecast further, plan for growth etc.
Behind a well-planned cashflow forecast will be a business owner getting to understand more about their business and we would like to believe that is one business that is less likely to fail.
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