The Top 4 Reasons Why Cash Flow Forecasts Are Vital To Business Owners

INTRODUCTION:

Most business owners have heard of the need to perform cash flow forecasts but very few are aware of the real benefits other than to have an idea what cash might be generated by the performance of the business.

So why does your accountant or business advisor keep harping on about this to you if you haven't performed a cash flow forecast?

Figure 1: Stop and think about the importance of cash in the bank and business planning

Here are my top 4 reasons.

Reason #1 What-if scenarios show how the same profit can be turned into more cash

When preparing any business plan, a 3 way budget not only projects the cash inflows and outflows but also shows the profit and loss, and balance sheet budgets. If you really want to get this right 3 way budgets are incredibly powerful and accurate as each budget needs to reconcile with the other so that they all balance.

Within the model, as you enter your data, you can enter:

• how long it takes on average for you to get paid by your customers;
• how long you take to pay suppliers; and
• how long you hold your inventory before it gets sold.

The averages of these can be obtained from your financial statements that you get each year from your accountant or you can use your cloud based accounting software such as Xero or MYOB or desktop program provided they have been reconciled and are reliable.

Here is the fun part! Just change any one or all of these slightly and then have a look at what difference it takes to the cash at bank balance.

Case Study #1

Bob and Sally run a small business that has a gross turnover for the year of approximately $2,000,000. Business is growing but they seem to be always struggling to find the cash to pay the bills.They decide to talk to their accountant John whose team speciliases in providing business advisory services and not just tax. He advises them to get a 3 way budget done to work out why there is minimal cash when they are making good profits.

An analysis of the financial statements show that on average over the financial year it's taking Bob & Sally's business 38 days to get paid. They are surprised. Whilst there are a few slow payers Bob felt that it would have been much lower than this as their trading terms are 30 days. John explains to them just by working on getting this figure down by 8 days the business would have $43,835 in the bank extra at any one point in time. He explains that if they could change their terms by giving their customers notice to 14 days (in some case with incentives), the extra cash at bank at any one point in time would be $131,506 and they haven't even looked at inventory or supplier days.

Bob and Sally are astounded. John nows works through the 30 different ways they can improve debtor days and a plan is hatched to concentrate on those that will work best for this particular business. Bob, Sally and John agree to meet each quarter to monitor improvement.

Reason #2 Being financially well organised shows the banks that you are thinking ahead

If you perform cash flow forecasts and you can see that you will be short of cash say 6 months into the financial year for whatever reason , the bank is far more likely to lend you the money or increase your overdraft if you tell them months in advance! Most people don't like nasty surprises and the bank isn't any different.

Case Study #2

Jenny and Simon run a small business. They have sat down and run their budgets for the next 12 months and after to speaking to their accountants at the quarterly meeting they realise that they their suppliers have warned them of an impending price rise for stock next quarter. Jenny and Simon are confident they can move the product as demand has been very good  lately and should continue. They have worked out that they could add an extra $75,000 to the bottom line (i.e. profit) if they buy in bulk.

The cash flow shows that they will need an extra $50,000 to do this in the short term. They contact their business banker Anna and they show her their projections. She is very impressed that they have thought this far ahead. The extension to the overdraft is approved.

Four months later Jenny and Simon have made an extra $75,000, the overdraft is gone and everybody is happy.

Figure 2: Planning Your Way Through The Maze Copyright Lara Scolari Gallery

Reason #3 Business plans need accurate financial projections to have any real worth

Business planning will invariably contain financial forecasts. Quite incredibly many business plans I see contain only profit and loss projections. These projections rarely take into account accurately:

• Loan repayments;
• How long it takes to get paid;
• How long it takes to turnover stock;
• Supplier payment terms whether they be payment required upfront or say 30 days;
• Dividends or drawings;

Reason #4 Businesses that show great cash flows get valued higher

If you are looking to sell, a business valuation Sydney will obtain much higher asking price if the business turns it profits into cash very quickly. Why is this?

• Less need for ongoing finance so that interest costs are lower (= more profit);
• Getting paid quicker means less risk of bad debts (less risk means higher multiples of goodwill);
• Good customers pay their accounts quickly so less likely they will need to be sacked (why pay for these customers when buying the business then?);

CONCLUSION:

Never underestimate the importance of budgeting properly. It's critical to your ongoing business success and is also a crucial part of any succession planning.