3 Essentials of Cash Flow Forecasting

One step that is often overlooked in managing the small business is forecasting Cash Flow. Even if budgets are created the critical step of translating the budget to a cash flow forecast is avoided. Why? Lack of time, lack of resources, and lack of knowledge regarding how are the most cited reasons. It often seems like an overwhelming process, even for accountants who are not focused on Management Accounting. However, this critical step that we provide for many of our clients is what has allowed them to reassess their business practices in time to make the necessary changes to keep them out of financial trouble.

Cash Flow forecasts are by definition rolling forecasts. I like to prepare a higher level 12 month cash flow forecast to see the larger picture and then a more detailed short term weekly forecast that runs for just as long as you reasonably can predict what will occur. That might be 4-12 weeks depending upon how quickly you collect your receivables and how predictable your sales are. I revisit the short-term forecast as often as necessary (daily, weekly, or monthly) depending upon the needs of the business and only reassess the higher level 12 month forecast if something has changed drastically.

1. In order to begin you need to know a few key facts about your business. The first is when you expect the revenue to come in. If you do not offer any terms and are paid up front, then your revenue forecast will be the same as your weekly sales forecast. If you do offer terms, then you need to continually keep a pulse on 2 items, the percent of your sales that are credit sales and your average days to collect your outstanding Accounts Receivable (A/R turns in financial terms). You will need to determine if these factors change significantly at various times of the year or if you can analyze them only occasionally. Initially I would look at them monthly to get a feel for what they are doing and how they are reacting to the economy. Besides being necessary for your Cash Flow forecast, watching these two numbers can also be an indicator of how your customers are reacting to larger economic events and what is happening in their businesses. Further, it can be an indication of whether you are being too lax in your own collection policy.

2. Secondly you need to do some analysis of your expenditures. You need to analyze when your own payments are due (how far ahead do you have to purchase to fill your sales demand, what percent of your inventory terms are prepaid, net 30, net 60?). Add to this the various weekly and monthly payments that are due such as payroll, insurance, rent, interest and loan payments, tax payments, distributions to owners, to give you a comprehensive layout of when your cash needs to be spent.

3. The third piece is your sources of funds outside of collections. If you have a line of credit that you can tap into or a loan you can draw upon, then you need to factor the limits of that into your equation.

Build a spreadsheet using all of these parts and I guarantee that you will more effectively stay on top of your cash flow needs. You will see the shortfalls before they occur. You will know how much cash you need to have each week and can then work on the various strategies to bring in cash more quickly, extend the time needed to pay your vendors, and plan your capital expenditures more wisely. Cash Flow Forecasting is one ore tool to allow you to run your business, not have it run you.

Budgeting.....cash flow style

Beth and I are big believers in budgets.  It gives a business goals and benchmarks to guide decision making and can warn of developing problems with enough lead time to make corrections.  When we create a budget, we use a cash flow format rather than a profit & loss format.   Budgeting solely on income and expenses can leave out major pieces of your cash flow: money tied up in accounts receivable and inventory and money spent on fixed asset purchases and making loan payments. 

Last year, one of our clients witnessed first hand the benefits of a cash flow based budget.  The business was experiencing a slight downturn in sales while costs (specifically wages) were up.  The client had a line of credit which was used to cover purchases in their slow period and our budget to actual analysis showed that in a few months, the line would not only be maxed out, but the expenditures were heading in a direction that would require even more money.  Because the budget warned of this trend, the owner was able to quickly make some changes.  She renewed efforts to bring in sales and she cut back on employee hours and thus wages by working a few more hours herself.  As a result, the trend reversed itself and not only did she not hit the upper limit on the line of credit, she actually was able to pay it down to nearly $0.

We recommend all small business owner try to get a line of credit.  Having a line gives a business flexibility during the slow seasons, it also helps during periods of rapid growth.  Having a line of credit requires good cash management because the bank will expect the business to use the line properly.  Proper usage dictates resting the line periodically (paying it down to $0).  All the more reason to have a cash flow based budget and comparing actual results to the budget every month to make sure you will have the money to use your line properly. 

Using your budget to grow sales

Now that you have created your budget for 2012, how do you get the most use out of it?  One way to start is the look at the revenue part of the budget.  How did you create it?  What kind of growth are you planning for and how will you achieve it?  You can use your sales growth goals from the budget to jump start your marketing plan.  You cannot hope to achieve sales growth without a concrete plan. This goes back to our earlier post talking about strategic planning and re-determining who your target market is and how to reach them.  You may want to sit down with a marketing professional to review your marketing plan and make revisions as necessary.

This is also a good time to look at staffing.  Do you have the right number of employees with the right skills to implement your budget for 2012?  Having the right people is essential to achieving your business goals.  Next week, we will talk about looking at your product mix and examining the contribution margin for each product you sell. 

Budgeting---quick and easy or detailed and effective?

The traditional budget process takes the existing budget and increases or decreases it by a certain percentage.  This is done as a whole for a really quick and easy method or line-by-line in a more detailed approach.  Either approach gets the job done quickly but are the results worth it?

There are several more modern ways to create a budget for a business: Zero-based, Activity based and Kaizen are among the most popular.  Zero-based budgeting reverses the process of traditional budgeting by starting each line item at zero. No reference is made to the current budget or prior spending levels, instead each expense budget must be justified.

Activity based budgeting groups the business expenditures by activities in the various functional areas such as administrative, sales and manufacturing.  Activities are tied to the strategic goals the company has set and the costs needed to fund the activities are the basis of the budget.  This technique allows a business to align its costs with its goals and objectives, reduce costs and improve business practices.

Kaizen is the Japanese word for continuous improvement and goes along with the lean process.  The budget is set based on future improvements in all areas which means the budget cannot be achieved unless the improvements are made.  This process forces a business to actually implement the changes it has developed during a strategic planning session or goal setting exercise.  The approach has a company work to minimize costs at all stages of the product life cycle and in all areas of the business.

All three of these techniques are much more time consuming than the traditional process but all three give more realistic and thoughtful numbers to work with.  The whole reason to budget is to help guide and manage a business better so even if the process is tedious, utilizing any of these techniques will help you grow your company and achieve greater results.

Budgeting process: expenses

The last two weeks, we talked about how to properly create a sales forecast for 2012 which will be used to set goals and also in your budget.  This week we will tackle the expenses.  Many people approach the expense portion of a budget with a broad hand: they increase costs across the board by a set percentage.  The better approach in to go line by line and gather your information.  Talk to your landlord, your utility provider, your insurance agent and find out what they anticipate 2012 to look like. You will also want to consider your staffing levels. If your forecast shows increased sales, will you need more employees? All of this takes time, but you will have much more meaningful numbers to work with.

The whole point of creating a budget is to guide your decision making during the year.  Can you afford to take advantage of a volume purchase discount?  Can you afford to hire more employees?   Is this the right time to expand or do you need to start accumulating cash in anticipation of an economic slump?  Putting together a budget is a little tedious, but the information you get from the exercise is well worth it.

Getting ready for the new year: sales forecast

Now that you have talked to your major customers and compared your year-to-date actual sales to your budget, you are ready to determine your sales forecast for 2012. While it is tempting to take the easy way and just bump up this year's sales by a set percentage, you will get more meaningful results if you put some additional thought and effort into the project. There are several techniques for arriving at a sales forecast and you will want to use all three and then set your budget where they intersect.

Technique number one for a retail business is to look at market statistics and see what the average sales volume per square foot of retail space.  You can then apply this ratio to your own store.  For other business types, the process is similar: look at average sales for the latest period available for your business sector.  This will give you a baseline for your sales, but you don't want to stop here as you may be comparing sales in Chicago to Boston to Kalamazoo and that isn't accurate enough.

The next step in forecasting your sales is to determine for your specific location, how many households needing your goods live within say, 5 miles. How much will they spend on these items annually, and what percentage of their spending will you get, compared to competitors? Do the same for within larger distances (with lower sales forecast figures). (Use distances that make sense for your location and business type.)  This step takes some time and research, but gives you additional accuracy.

The final technique is to set a sales budget for each product or service you offer. Use categories of products if you have a larger number and variety offered. If you offer say, four types of goods plus two types of extra cost services, estimate sales revenues for each of the six product/service lines. Make an estimate of where you think you'll be in six months (we should be selling four of these items a day, plus three of these, plus two of these) and calculate the gross sales per day. Then multiply by the number of days you will be open for each month in question. Now scale proportionately from month one to month six; that is, build up from no sales (or few sales) to your six month sales level. Now carry it out from months six through twelve for a complete annual sales forecast. You will be using the numbers from the first two techniques as a guideline as you develop this forecast.

Congratulations.  you have now completed the sales portion of your 2012 budget.  You will want to check actual to budget at least once a month to see where you are and what adjustments need to be made. 

Next week, we will work on the expense side of the budget.

What Do You Need to Do Before Year End?

Yes, we know it is only the beginning of October, but this is the time of year we like to get our clients starting to think about the end of the year.  Some procedures take time and others require setting up meetings so it is good to get a jump on the process.  This is the time to compare your actual results to your current budget.  This will give you some of the information you need as you create next year's budget.  Consider what the variances are and what caused them. After you get an understanding of where you are now, think about where you are going next year.  This is a good time to touch base with your major customers and find out that their plans are for the next year.  Do they anticipate purchasing the same amounts next year or more? Or less? Based on the results of these conversations, you will want to update your marketing plan.  This will help you set your milestones and metrics so you can achieve your sales goals. The next step is to create your budget for next year. A good budget is like a good map and it will help you navigate through the next year. 
You  also need to meet with your tax advisor. This is the perfect time for your advisor to see where you are so you have time to make decisions and adjustments before the end of the current year.
Getting these projects done now will allow you to concentrate on the end of this year and start 2012 with a bang!

Year End Planning

Beth and I have been meeting with all of our clients to get them started thinking about plans and goals for their businesses in 2011 and to get feedback on our performance in 2010. 

Those who have meet with us have expressed the feeling of satisfaction that getting organized for the new year has given them.  Those who have been working with us on their budget for 2011 have really been happy with the feeling of control having a budget and a plan has given them. 

Budgeting can be a little tedious, but the results are well worth the efforts.  We encourage our clients to use flexible budgeting which means when we compare budget to actual each month, we discuss whether the variations are controllable or whether the information or assumptions we used to create the budget may have been inaccurate.

Budgets help not only with controlling expenses, they also give a small business owner income goals to meet. 

Start thinking about the New Year and let us know how your budgeting and goal setting is going!

Budgeting......it's not too late!

What are the components to a good budget?

Yes, we are back to budgeting. It is only mid-February so there is still time to create a great budget for 2010. Your company’s budget should really be assembled as a master budget which is made up of an operating budget, a financial budget, a capital budget and finally a sales budget.

The operating budget deals with your basic business operations: what do you need to run your business? Categories in your operating budget will include marketing budgets, staffing (employees costs), as well as other expenses related to running your company. Take the time to talk to vendors and suppliers so you have good numbers to work with.

A financial budget is concerned with where the money is coming from to keep your business running. How are you going to obtain all the resources you need to run your business? This is looking at your cash flow and determining the timing of when money comes into your company through sales and collection of receivables and when money goes out through payment of expenses, purchases of inventory and other assets as well as payments to yourself, the owner. A line of credit from a bank is the best way to deal with timing issues in your cash flow. In light of a continuing tight credit environment, many small business owners are relying on credit cards to manage their cash flow. This can be a dangerous path to take if your balances push you into high interest rates.

Your capital budget is for evaluating and determining the growth of your company. Careful analysis is recommended before purchases of fixed assets are made or a new product or line is launched.

As you can see, a good budget deals with much more than just expenses. Now let’s talk about revenue.

Creating a good sales budget depends on good research and goal setting. This is a good time to look at where you fit in today’s economy. What is your competitive edge and how are you communicating it to your target market? After you have analyzed trends in your market and your industry, you can create a good sales forecast for your business. Next you will want to write down short-term and long-term goals detailing how you will achieve your sales as forecasted. All this work will allow you to set up a workable and helpful sales budget which when placed into your master budget will give you a masterful tool to manage your small business.

Budgeting Part III: How to use your budget to manage your business

The question that I often receive from small businesses regarding creating a budget is “What’s the point?” Underlying that question is the real question, “How do I use a budget to help me manage my business?” So let’s attempt to address that question.


First of all, when we talk about creating a budget, we usually mean a Pro Forma Profit and Loss Statement. In essence, if everything goes as planned, this is what our profit (we will only think positively here) will look like. I recommend taking this one step further and also creating a Pro Forma Cash Budget, budgeting for when you actually expect to receive and spend your cash. This will allow you to anticipate when you are going to have an abundance of cash and when you are going to have some cash needs so that you can plan for them. For example, if you run a retail business you can expect to do most of your business in November and December so you will end the year with a large cash balance. Before you spend it all or hand out large bonuses, look at your Cash Budget for January through April to see how much you money you need to keep in cash to get through those tough sales months.

Once you have your budgets prepared and you have finished your first month in the new year, do a comparison between your actual amounts and your budgeted amounts. Most importantly, be sure that you can explain the variances. If your Cost of Goods Sold is higher than expected you might want to be sure that it is because your Sales are higher than expected as well. If your labor expense was higher than anticipated can it be explained by an unanticipated order or have you not been watching your overtime closely enough? If you are a restaurant and your food purchases have increased but your sales have not, you may need to make sure that someone is not stealing food from you.

For each of the explained variances you will also want to consider whether it is a one-time anomaly or if this is something that you expect to continue. If it is a one-time event and you have overspent your budget then you know that you will need to adjust your spending down in a different month. If it is an event that you expect to continue, then you will want to adjust your budget to take the change into account. The favorable adjustments are easy. It is the negative variances that require some decisions on the owner’s part. Just remember that you developed your budget based upon your company’s strategy, which means that you need to make sure that all adjustments to your budget are also in line with your strategy.

The point of a budget and a good financial management policy is that you have planned for what you expect to happen and you are now analyzing the data and reacting quickly to your business needs.

A strong grasp of your business finances is essential to running a successful business. As with all things financial, if you find that this is not one of your strengths, then don’t just push it aside and ignore it. Get the help that you need.