Cashflow (or to be precise, the management of it) is the lifeblood of a business. Whereas profit is the veins and arteries of the body, cashflow is the blood. Without it, the brain doesn’t get oxygen and the body (your business) dies. So its a great idea to properly manage cashflow by forecasting what is going to happen to your balances long and short term.
What is cashflow?
Cash flow is a term broadly used to define any movement, historic or forecast, of cash in or out of a business.
It is vital to the survival, success and sustainability of any organisation. If you can master cash flow management and financial planning, you’re streets ahead of most businesses and its the stuff on which a QR3 part-time finance director is brought up.
According to a recent study by Dun & Bradstreet on business failures, companies that do monthly cash flow planning have an 80 percent survival rate – against the 36 percent survival rate for those doing it once a year.
Terms used in cashflow
Its useful to understand the various terms used when talking about cashflow. Here are the basics. Inflow is about getting paid by customers and cash from other receiveables. Outflows are payments out such as cost of employees, of materials and services, of overheads – our suppliers.
Inflow covers all the ways your business brings in cash or gets paid. For example, cash sales, collection of payments due from debtors and return on investment make up cash inflow.
It is extremely rare that a growing business is sitting on large cash reserves. So, focusing on how to constantly bring more cash through the door should be a top priority for any business owner. There are ways to help increase the rate of cash inflows by taking up various financial products (like invoice discounting and factoring) so that you get paid more quickly and more frequently.
Outflow covers all the ways your business spends money. It includes everything from buying stock, paying the rent and business rates to employees and taxes. When you consider all the ways money can leave your business, it can be daunting to try to keep your costs down. But there are a number of ways you can moderate and space out the timing of your outflows to balance better with your inflows.
The important thing to keep in mind is that, for your business to be successful, cash in should be more than cash out. Negative cash flow is easily the biggest pitfall for any business – large or small. If you can transform your business so that it sits on cash reserves, this can actually reduce your costs of borrowing for expansion as funders perceive a lower risk in your business model.
Common misconceptions about managing cash
There are many misconceptions or myths about managing cashflow.
First of all, many businesses think that if they show a profit then the cash will look after itself (i.e. cash doesn’t need managing). In reality, this can only happen if you manage your cashflow wisely and understand the difference between cash flow and profit and loss. Cashflow is the movement of funds in and out of your business, whereas profit is the excess of income over expenses or, in the case of loss, expenses over income.
Another common cash flow myth is that forecasting is a waste of time. Some claim it can’t be done, saying there are too many variables such as the economy, unexpected expenses, etc. Sure, there are variables. Look at Brexit, for example. Immediately following the referendum there was a 10% devaluation in sterling. Impossible to manage? Well, the reality is, there were many economists forecasting a devaluation weeks before the referendum took place.
Understanding the history of your cash flow over time can also help you when you need to be a little tighter on your bank account, when the business coffers are up and you’re in a good position to spend, and when you may need to reduce expenses or borrow if necessary.
A planned and strategic approach to borrowing is going to be more welcomed by funders than an emergency requirement stemming from poor planning.
Forecasting your cash isn’t just possible, it’s an absolute necessity when it comes to managing your business effectively.
Managing cash flows
Everyone budgets their cash if they want to stay afloat. Its no different with a business, except in business its called cash flow management.
Cashflow is to business what oxygen is to human beings. To measure the health of the cashflow pipeline, a business should monitor current cash balances with the immediate cash demands (wages, suppliers, rent etc.) A daily check on your cash balances and immediate outflows is a good check to have in place – especially in a recovering or a new business. It is easy for business owners to do this on their own and there are tools out there that can help.
Forecasting the cash position needs a little more skill. A part-time finance director could help here if you don’t have the capability in-house. But, if you want to try for yourself, here are some simple steps to follow. First time round, its a big exercise, but once you have the process in place and a system to follow, it takes less time.
- On a spreadsheet (easier than a piece of paper), log all of your known inflows by date (weekly or monthly depending on how critical)
- Log all your known outflows as above
- Input your opening balance
- Calculate your closing balance after inflows / outflows (often referred to as ‘movement’)
- Step back and review your closing balances – look at the peaks and the downward spikes
If there is a cash requirement (a negative balance) then look at different strategies to fund so that you stay in the black – delay a payment if you can, with agreement of the payee, delay spending on a non essential project, apply for an overdraft or other working capital funding.
In a turnaround situation, I instigated a rolling 13 week forecast. I knew, week by week, what my cash spikes would be (and the troughs too) for the following quarter. This meant I was able to talk to the bank manager, or other shareholders for temporary injections of cash weeks before I actually needed it. And what’s more, I could tell them when they would likely get their money back.
So, generally, try to do a 13 week rolling forecast and also have a 6-12 month forecast review on a quarterly basis. The former will ensure 3 months warning of a cash spike, giving you time to take tactical action. The latter will help you identify seasonal issues which a change in strategy could help to address – thus making your business more robust.
Do all these things and your shareholders, bank manager, other lenders – all should love you. If you don’t, you’re taking a gamble on your businesses future.