If you heard there is one single reason that eight out of ten businesses fail, what would you guess it to be?
If your answer was “inadequate cash flow”, you’d be right. Managing and anticipating your cash levels is crucial to the success and longevity of your business. If you thought your business would have more money than it does at any given time, you might find yourself unable to pay salaries or meet other vital commitments. Next minute you’ll find yourself borrowing money at high interest rates to cover costs you had expected to cover debt-free. It’s often the beginning of a downward spiral: you become more and more dependent on the income from the next “big deal”, and your company becomes unable to meet its financial obligations in the interim. That’s why the Australian government tells business owners that a cash flow projection is the “most important” business tool for every business. Not just the large ones, or the listed ones or the start-ups. Every company depends on an accurate cash flow projection for success. And that includes yours.
There are a few basic steps to completing a cash flow projection for your business. Eric Parker’s Run your own business and make lots of money provides some pointers.
Start off by deciding the period your forecast will cover. Then follow the steps below.
- Compile a sales forecast: Complete a spreadsheet indicating the expected products you will sell, the number of units and the price they are to be sold for. Have one line for every day of the month.
Existing businesses can look at their previous year’s sales and adjust for trends in order to derive these figures. Start-ups will need to make estimates. Business Victoria makes the observation that sales figures are constantly changing because they depend on various factors such as the types of customers you sell to, their required payment period, the health of the economy and so forth. So complete accuracy is almost impossible, but the more informed your estimates are, the better.
- Compile an expense forecast: List all of your company’s expenses. This list should be exhaustive. Consider things such as advertising and marketing expenses, insurance, bank charges, legal fees, rental expenses, stationery and postage, travel expenses, salaries and so forth. Parker points out that while loan repayments are not generally seen as an expense, they should be recorded in this category for the purposes of the cash flow projection.
- Compile a profit and loss statement: The next step in your cash flow projection will be to take the totals from the sales and expense forecasts and calculate what your profit or loss will be. In a nutshell, this will require you taking the total sales minus the costs of sales and the expenses to derive your net profit before tax.
- Pay attention to your cash on hand: The opening bank balance for each month represents your expected cash on hand. The closing bank balance should equal how much cash you expect to have available at the end of the period. This, of course, becomes the opening bank balance for the next month.
- Compare your cash flow projection with your actual: An important part of maintaining financial control over your business is the retrospective review you conduct. Compare your cash flow projection with what actually took place. Did you have more cash in hand than you expected? Did you find you came up short every month?
Use this information to plan a more accurate cash flow projection the next time round. In some cases, the expected amounts may have been accurate, but the expected timing panned out differently to what you anticipated. Learn from this. Cash flow projection is all about timing – it’s just as much about when you have the cash as it is about how much you have.
The importance of a rigorous and accurate cash flow projection cannot be overstated. If you find yourself lacking the time or confidence to compile one, it’s worth bringing in someone to do it for you. The Finance Team can help identify an experience finance professional to help you carry out this task as often as you need it done.