It’s obvious why you need cash – you have to pay suppliers, and perhaps employees, and you may have to rent premises or buy equipment. Even if you take out a loan for the equipment, you will need cash to service the loan.
You may also operate a seasonal business, or at least one where the turnover is up and down throughout the year, so you need to ensure that you bank enough cash at the busy times to see you through the downturns.
Cash flow is simply the movement of cash in and out of the business, and the process of forecasting and predicting that movement is an essential part of running any business, large or small. There are a number of methods that one can use, and you will probably get a different suggestion from everyone you ask. Most accounting software provides a cash flow template, and there are any number of spreadsheets that can be downloaded online, so I am going to concentrate more on principles as opposed to specific techniques.
Step one is to establish what you are spending. Make sure you list everything – a good place to start is your bank statements – including office stationery, travel and entertainment. If you need to spend company money on it, then it goes on this list!
After that, list your income. It’s critical that this is realistic and, as you move forward, is adjusted for any fluctuations that have occurred – the loss of a large client or contract, or a bad debt. Remember one critical factor about income, though – allow for the time it will take for the customer to pay you. So if your sales in January are £25,000, and your terms are 30 days payment, then split the income between February and possibly even March.
You may know from observation, for example, that 10% of your income is from late payers. Therefore, of January’s £25,000-worth of invoices, predict that you will receive the bulk of it during February, but £2,500 will show up in March.
This particular issue won’t apply, of course, if you are operating a business where you are paid in advance, or at the point of sale. Because you get the money on the day, you don’t have this problem to worry about, so it’s always a good idea for cash flow purposes if you can think of some products that you can sell on the same basis.
If you suffer from a lot of delayed payments, there are various ways of factoring your invoices so that at least some of the balance becomes available almost immediately, and this can help significantly with cash flow. Remember that it comes at a cost, though, and once you’ve done it there is nowhere else to go, so make sure that factoring is put in place for the right reasons – it isn’t going to help as a temporary fix for a bigger problem in the business.
Equally, remember that a purchase can be ‘deferred’ if bought on a credit card, or some other delayed payment method – put the purchase into your cash flow on the date that you pay the credit card bill.
If you are registered for VAT you need to be careful. For many business purposes you ignore it, for example you will always think of your selling prices internally as net values, exclusive of VAT. For cash flow purposes, however, you need to record income as VAT-inclusive invoiced values, and your purchases from your suppliers should be recorded similarly. Then, of course, you need to record the VAT payment to HMRC as an expense in the month during which it will become due.
The cash flow position is then established by comparing income and expenditure for a given month, and referencing the bank balance, to see how much cash you are likely to have in the business. Don’t forget that you need to watch the cumulative total – if you spend £5,000 more than you earn during January and that has been funded by reserves (money already sitting in the bank) then you need to recover it in February.
The key thing that you are looking for is the likelihood of a cash shortfall at any point. This is probably the main reason for preparing the forecast, so that you have a bit of warning if you are likely to hit a problem. It won’t tell you what you can do about it, but it will tell you how long you have to react. It can help you pinpoint problems with slow paying customers, and forces you to keep an eye on expenditure.
Parties interested in your cash flow
Additionally, any organisation providing funds for your business will insist on reviewing it regularly. Banks, shareholders and other investors will all be taking a keen interest in the cash flow, and if you are starting out it forms an essential part of any business plan.
Typically, you will track the actual income and expenditure against the budget numbers in the forecast, so as time passes the accuracy of your predictions should improve. Most templates will support this budget/actual logic, and while you are homing in on the more accurate figures you could consider preparing a couple of ‘what-if’ forecasts – once you have generated the one you think is correct, run a copy with the income increased by 10% and another with a 10% decrease in sales.
On the basis that the sales are the most variable element of the forecast (your expenses should be pretty straightforward to predict accurately, apart from a cost-of-sales aspect that may relate to the sales) this will give you a good indication of what will happen if your initial predictions are wide of the mark.
At first, cash flow forecasting sounds very complicated, but I hope that this post has shown you that it need not be too difficult to create a powerful and valuable tool for your business. Even if you don’t have to do it for a bank or an investor, you should get great value out of doing it for yourself, so make it a regular part of your budgeting and administration.