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.

Managing cash flow

When I was a young accountant, someone gave me a button that said "I Love Cash Flow".  I had it pinned to my cubicle and I often teased my co-workers when they would ask to borrow money for lunch near the end of the month that they, as CPA's, should be able to manage their personal cash flow better!  Cash flow management has many components and we will address them over the next few weeks.

 A business can take a couple of simple steps to manage its cash flow.  The first thing you can do is to compare the terms your vendors offer to the terms you offer your customers.  If your vendors expect to get paid in 15 days but you give your customers 30 days to pay, you are going to run into problems.  A business should consider what its competitors are offering as far as terms go, whether the customer has earned lengthier terms and what kind of flexibility it has with its vendors.

It is not unusual to require payment up front or at the time of service for new customers and then to offer extended terms once a good relationship has been established.  It is a good idea to do a credit check on any business you are considering offering extended terms to. 

If your vendors are unable to offer lengthier terms and you feel you must offer longer terms to your customers, a line of credit may be the answer.  This will provide your business with the funds to pay your vendors and then you can pay it back when you are paid by your customers. 

Receivables and payables are just two components of cash flow.  We will discuss others in the weeks to come so stay tuned.

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. 

Why do small businesses fail?

Even though the economy is starting to turn around, we still see too many small businesses closing their doors.  Why?

• The business didn't take the time to understand what set it apart from it's competitors or didn't articulate that to the market clearly enough.
• The business wasn't set up for success.  A well developed business plan wasn't created which listed all the start up expenses and assets required and located the funding for these expenditures.
• The business didn't know what it's break even point was and didn't systematically determine it's pricing.
• The owner wasn't prepared for how hard a small business owner has to work and the sacrifices that need to be made during the start up years.
• The owner lacked the people skills to effectively deal with employees, customers and vendors.
• The business didn't have proper financial information to make decisions and change strategies.  Good financial statements are NOT just for your tax preparer to use.  They help you understand what is or is not working in your business.
• The owner had insufficient or irrelevant experience to run their own business.  Many people who have always been an employee have no idea what it takes to be a business owner.  The owner of a small business has to know about labor laws and tax codes and licensing requirements and record keeping rules........

It breaks our hearts every time we see a business with a good product or that offers good service fail because it didn't have the proper infrastructure or organization.  We have often thought business owners should be required to take a class so they do understand all the rules and regulations they need to follow and all the other things they need to understand. 

Grow your business thoughtfully

Beth and I are finishing up a class we are teaching on business planning. The last topic of the course is growth or more specifically, planned growth. While the word growth may sound wonderful after the agony small businesses have suffered during this economic downturn, uncontrolled growth can bring disaster. There are three main problems uncontrolled growth can cause:


Cash flow is the most frequent problem that occurs if a small business does not plan and control its growth. More sales mean more cost of goods sold which means more purchasing which means more money to be paid out for purchases. How are you going to fund your growth? Can you arrange for extended terms from your suppliers now that you will be ordering larger quantities? Can you require a deposit from your new customers and use that money to fund your inventory costs? What is your relationship with your bank? Talk to your lender and see if the lending environment in your area will provide you with a line of credit to fund your growth.

The next issue growing businesses face is management. This usually occurs when another location is established. Make sure your existing operations are stable and well managed by someone else before you turn your attention to a new location. You will notice I said you. New locations should always be run by the owner or existing upper management. This will insure a continuation of the processes, procedures and philosophies that have made your business successful to date.

The final problem is maintaining quality. We have all witnessed what has happened with Toyota in the last month. It is debatable whether the company’s problems stem from poor management, greed or losing sight of what made them successful. Whatever the cause is, it is a lesson to be learned by all businesses. A company must stay focused on its core values and mission in order to succeed.

We all hope that growth is in the future for our own businesses and for our country. Just make sure your growth is planned.

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.

Focus Your Business With An Effective Budget: Part II

So how do you create a budget for your small business?

In these challenging times, it is more important than ever to put together a comprehensive budget for your business to use in the next year. We recommend creating both a budget for your Profit & Loss and a budget for your Cash Flow needs. For those of you who are new to the budgeting process, here are a few pointers:

Pull out your prior years’ income statements and look at your historical data. Which income streams have been most successful for you and have provided you with the highest margins and therefore the most money? Which products or services have not performed as well as expected? Consider whether they can be improved and if not, eliminate them.

Look for patterns in your income stream and expenditures. If your money coming in from sales doesn’t match with timing of your major expenses such as seasonal inventory purchases, real estate tax payments or insurance premiums, setting a budget can help you make sure you are saving enough money to pay for these items.

Think about using zero based budgeting. Don’t just take last year’s budget and add an arbitrary increase in sales and expenses. Do some research and consider what a reasonable sales figure will be. Figure out what your staffing needs will be based on this sales figure. Talk to your major suppliers and your utility providers and see what price increases may be in your future. Consider what items are necessities and which expenditures are really luxuries. Evaluate every item in your budget and consider whether it is in line with your strategy for your business. With the economy still recovering, you need to maintain a lean approach to both your budgeting and the actual managing of your business. There is a wealth of information available to help you with the creation of your budget if you do a little research.

A well planned budget process can take some of the stress and fear out of managing your cash flow throughout lean times and allow you to spend your money wisely and avoid running up credit card balances.