As a small business owner, you need a deep understanding of your business finances. You need to understand your profit and loss statement; you need a rock-solid plan to pay off your debt; and you need to have an understanding of cash flow forecasting.
A cash flow forecast is used to predict a business’s earnings and expenses over a given period of time.
A cash flow forecast often goes beyond the money in your savings account (though that’s a good start). On OPEN Forum, an online presentation from executives in the financial industry, the topic of cash flow forecasting was covered by Evan Singer, CEO of SmartBiz®, Michael E. Chadwick, principal of Chadwick Financial Advisors® and Vernon Tirey, co-founder and CEO of LeaseQ®, an online leasing marketplace.
Here’s some of their expert insights about this important topic.
“[C]ash is king for a small company,” said Singer. “So they generally have to build an actual cash flow forecast to understand how they’re going to grow their business over time.” Chadwick added, “I would argue that without forecasting cash flow, you can’t run the business effectively. If you don’t have a solid cash flow model, you’re likely running your business very dangerously.”
Tirey also pointed out that cash flow forecasting can often protect small businesses from unwelcome surprises. “An employee leaves and you have to replace them, someone pays late that you were expecting to pay on time, a deal doesn’t come through that you were counting on—those kinds of surprises are happening every month. When you have a forecast and cash flow worked out, you have a better understanding of the impacts of these types of surprises and can start developing strategies to deal with them.”
Many small businesses don’t do cash forecasting at all. As Chadwick explained, they might be too optimistic. “They are building a forecast where everything lines up in an ideal world. We all know the world doesn’t work like that. So I’d build it somewhat pessimistically. Reality should come in more optimistically and they’ll be fine.”
Borrowing too aggressively is another pitfall with cash flow forecasting that may lead to negative cash flow. As Singer pointed out, “The biggest error from a lending perspective is businesses will take fast and easy money that’s expensive and has a high monthly payment versus spending just a little more time to get a loan with a much lower monthly payment. If a business can get a loan with a lower monthly payment, like an SBA loan that has a longer term and lower interest, they generally should take advantage of that opportunity.”
And Tirey offered a good reminder for us all: “As we say in Texas, you want to make sure the milk check is bigger than the feed bill. If you’re buying a piece of equipment, you want to know what your monthly revenue is going to be from that equipment, and what your monthly expense is going to be. Don’t spend cash on equipment you can lease or take out a loan for. If you look at it on a monthly basis, that can likely make a big difference in cash flow.”
First and foremost, come up with a system for managing your cash flow. Then, write it down. “I usually have my people report monthly. People who do this regularly often make projections that are more accurate. People who only do it once in a while are generally not as accurate. So consider doing it, do it consistently, and compare projections to results,” Chadwick offered.
Singer added that pinpointing what’s helping and hurting cash flow can make it easier to improve it. “For instance, they might identify that they have high debt payments. If their monthly payments are high with the loans they have outstanding, they can refinance those into a lower monthly payment to save on cash flow. Or, if many customers are taking 120 days to pay, they can work with them to get that down to 30 days and can improve cash flow that way.”
Forecasting your business’s cash flow tells you if you’ll have the future cash to run and/or grow your business over a period of time. It can also help you avoid costly surprises.
Learn more about cash flow and issues you may face as you operate your business on the SmartBiz blog: 3 Cash Flow Problems That Hurt Your Business and How to Solve Them.