How to Take Control of Your Cash Flow with Forecasting

Piloting your business in fair weather is challenging enough. But it’s even tougher to navigate the economic climate during unsettled times like these, especially when it comes to the financial aspects of your business.

What is Cash Flow and Why is it Important?

Cash is the fuel for your business. Without it, you can’t keep moving forward and continue to operate. That’s why cash flow forecasting is by far the most important cash management tool for business. It’s incredibly important, especially during our current circumstances, as you chart your course for navigating what may become our “new normal.” Your cash flow forecast will be invaluable, not only in guiding you to success, but in measuring your progress.

The Difference in Cash Flow and Revenue

Cash flow is not the same as revenue and does not flow through your business in the same way. Income, or revenue, is not cash until a receivable is collected or cash is injected into your business from another source. To optimize your cash flow forecasting and use of cash, it’s important to take a deep dive into understanding how CASH flows through your business.

How to Prepare a Cash Flow Forecast

Initially, you can keep the forecast very simple then develop detailed calculations over time. Consider cash as either coming in – “Source” – or flowing out – “Use.” As a starting point, review your current financial statements and operating budgets.

Identify all “Sources” of cash. Sources of cash are typically easily identified and include the following:

  • Cash sales (such as ecommerce, minus fees)
  • Deposits against contracts
  • Collections of accounts receivable
  • Payments on notes receivable
  • Capital injections from investors or owners’ equity
  • Loan proceeds (including Payroll Protection Program funds – which is cash, NOT revenue)

Review sales projections to ensure they’re realistic then ask, “How and when is the sale converted to cash?” Get a visual by developing a spreadsheet for forecasting the time when cash results from sales since that is the main source of cash flow. Ask yourself the following questions when building your spreadsheet:

  • Is cash received at the time of sale or is there a timing difference?
  • If you sell on account, when is cash actually received?
  • What percent of receivables are never collected? During these unusual times, history may not be a reliable basis for forecasting receivables so your forecasts should be monitored and adjusted according to actual receipts.
  • Similarly, go through all the other sources of cash and understand the timing of receipt of each.

Next, identify all “Uses” of cash. Just as cash is not the same as revenue, uses are not the same as expenses.

To forecast the “Use” side, review the Income Statement, starting with the Cost of Goods Sold section. If yours is a product based business there must be a clear understanding of how inventory is purchased, processed and delivered. If yours is a service business, then understanding the timing of payments to employees and subcontractors is critical. Owners of service businesses may be surprised by the amount of cash expended before receipt of payments from sales.

After creating a clear picture of Cost of Goods Sold, each operating expense should be reviewed in terms of its timing. Then review the Balance Sheet of both assets and liabilities to determine additional cash outlays expected in the future. Examples of “uses” of cash include the following:

  • Cost of goods sold / inventory
  • Payroll taxes and benefits
  • Sales and marketing expenses
  • General and admin expenses (overhead)
  • Finance expenses
  • Distributions
  • Credit card payments
  • Loan payments
  • Sub-S Distributions
  • Capital expenditures – equipment, fixed assets, etc.

A forecasted cash flow should include both a summary sheet and detail sheets for each “Source and Use” line which provides space to document assumptions. The last section of the forecasted cash flow provides a running balance of the projected cash balance, based on these sets of assumptions, indicating whether you have a positive or negative cash flow. Determine your burn rate and cash position. Do you have enough cash to get through the next 90 days? Your cash flow forecast can help you implement an action plan if a review of the projected cash balance projects future shortfalls.

How Often Should I Forecast Cash Flow?

If cash seems really tight, do a forecast weekly, factoring in your priorities, i.e. can you meet payroll? Otherwise, you need at least a three month cash flow by week, prepared monthly, and a twelve month cash flow forecast as part of the annual operating budget.

During this coronavirus era, or in other uncertain times, it’s helpful to do both a “hopeful” and a “pessimistic” forecast, using numbers that you think are realistic for each situation. This will give you data you need to make what may sometimes be hard decisions in terms of the actions you need to take to have cash.

Moving Forward

The cash flow forecast typically generates a change in how the business operates from a cash flow perspective. It provides not only an understanding of how cash moves in and out of your business, but insights into how to optimize the wise use of your cash. Cash flow forecasting is both a science and an art. On the art side, your experience comes into play, as do your culture, your values, and the cornerstones of your business that guide your choices and decisions. So no two business’s forecasts will be identical.

There’s a lot to know when it comes to forecasting cash flow. But once you’ve done it you’ll wonder how you ever operated without this invaluable tool. For more tips, check out my recent presentation on cash flow forecasting, as part of The Alternative Board’s (TAB) Business Owner Success Series. Please also feel free to contact me with your questions or for a free template for developing a profit plan.

Rick Arthur

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Rick Arthur is a CFO whose expertise is built on Financial Intelligence and 35 years in senior financial roles. Coupled with a CEO’s perspective and the experience of building his own $20 million company, he brings a unique depth of insight into business from the top down. Wired to get to know people, Rick works hand-in-hand with business owners of intentional, growth-oriented companies, solidifying relationships as a trusted advisor and confidant to his clients. He leverages his experience to help business owners gain traction and stay laser-focused on the company’s vision, cash flow, and profitability – all while creating big picture solutions for strategic planning, growth and sustainable success.