When business owners are confronted with a difficult decision, it can be hard to know which course of action is best. Financial statement forecasting and scenario projections can help estimate financial outcomes, but projecting revenues and expenses will only get business owners so far. There are other metrics that should play into their decision.
Cash flow is one of those metrics that is often underutilized. Not all entities create a cash flow statement, and those that do often do not know how to use their data to help inform decisions. But cash flow reveals a lot about the health of a company, and cash flow forecasts can help ensure future needs are met.
What Are Cash Flow Forecasts?
Cash flow forecasts predict the amount of money coming into and going out of a business over a specified time period. To keep tight control on cash, some companies forecast cash flows only three or six months out, but when considering decisions that will affect the long-term health of the company, this reporting period may need to extend to 12 months or longer.
Forecasting cash flow will be difficult if your policies are not clearly outlined. Before you embark on a new project where you will need to closely monitor cash, implement strict procedures around cash flows. For instance, you can have cash in hand much more quickly if you change your payment terms from net 45 to net 30 or if you invoice three days sooner. But the key factor here is reliability. If you need to keep your payment terms at net 45, that’s fine; just make sure your team processes invoices and deposits receipts timely so you can accurately estimate your cash activity.
Your cash conversion cycle (CCC) will be a useful model when forecasting because it shows how long you need to wait before receiving your next influx of cash. Your company’s CCC shows your cash generation process from beginning to end and will answer the question, “how many days does it take for us to convert our initial investment into cash flow from sales?” Because you can have a CCC for each type of revenue that you earn, you can predict how your cash flows will feed future investments or bolster your operations if there is a disruption.
How Can Cash Flow Forecasts Help?
When utilizing financial forecasts of any kind, including cash flows, you should (1) compare your forecasts to actual performance, and (2) update your forecasts regularly. If your spreadsheet is dynamic, you can easily update your forecasts based on your performance. These small tweaks will ensure your cash flow trajectory stays on target. Dynamic cash flow forecasts can help you:
Identify shortfalls in income.
Although income and cash do not always correlate, in many industries, one often precedes the other. By reviewing your CCC, you can see where income recognition falls in your cash cycle and correct course if cash reserves get too low.
If you’re running short on cash, there is a reason why, and excess spending may be the culprit. You may not notice an extra expense here or there when you review your month-end trial balance, but you will certainly notice it when you see a dip in your cash reserves.
Avoid overdraft fees.
If you review your cash flows each month, you will know if you’re in danger of overdrafting your account. Overdraft fees can add up over time, so avoiding even a small $25 fee will pay off.
Stay on top of overdue payments.
If you have an unexpected surplus of cash, trace what happened. You could be overdue on making debt payments.
Identify cost increases.
Cost increases can sneak up on you if you’re not carefully monitoring them. Reviewing cash flow regularly will help you identify when this happens. If a vendor raises prices on you, you’ll see it in real time and can negotiate a new deal or search for a new vendor.
Inform financing decisions.
When you’re considering a big purchase, you need to have the cash to support the initial cost outlays and future debt payments. A cash flow report (even a quick, informal one) will reveal if you have the room to take on additional financial commitments. It can also help you determine what loan terms (payback period, monthly payment amount, interest rate, etc.) are feasible for you to take on.
Your cash flow assessment will let you know if you have excess cash. With this knowledge, you can invest that surplus, pay down debt, upgrade equipment, or something else that will be more useful than carrying it from month to month.
Most importantly, monitoring cash flows is an act of good governance. Your stakeholders, board members, and investors will appreciate knowing that your cash is being monitored regularly. This trust will build over time and will pay off if you need additional investments in the future.
If you have a cash flow conundrum or want help setting up a system for monitoring cash flow for the first time, reach out to our team at Landmark. We’d love to help!
Want to read more about cash flow? Check out the posts in our cash flow series below.