By Carl Faulds
Maintaining a positive cash flow is essential to every business, but particularly for SMEs, that may have less access to large and affordable overdrafts. Forecasting is the tool that will tell you whether you have the cash you need to meet your obligations and grow your business. In short, it will inform you whether more cash is likely to leave your account than enter it.
So what’s the best and easiest way to prepare a cash flow?
First, forecast your sales
If you have an established business, looking at last year’s sales figures should give you an idea of how you are likely to perform this year. You should also factor in any trends based on recent increases or decreases in sales. For a new business, you will have to start the process differently–by estimating your likely expenditures.
Consider your expenditures
When calculating likely expenditures, you need to factor in the cost of producing your goods or providing your services. This will enable you to produce accurate projections of your costs if unexpected orders suddenly come in. At the same time, you will need to consider your fixed expenditures–the cost of maintaining your premises and paying your staff, as these commitments need to be met whatever your order volume.
Look at potential investments
Of course, routine expenses are only part of the picture: you may also need to invest in the business to grow it. In particular, you may need to purchase new equipment or fund a larger premises or new staff members to deal with an upswing in business. For this reason, you should regularly revisit your cash flow projection and adjust it in line with changing business conditions.
Assemble all your figures
Having decided the period you wish to forecast, you can now bring all the figures together and base them on your opening balance (your cash at hand). Add in your projected outgoings and income, month by month, and you will have a clear vision of where your bank balance should be a week, a month, or a year down the line.
Compare your projections to reality
Perhaps the most important step is to compare your actual results to your projections, so you can see whether you made any errors in your forecasts. By constantly reviewing where you are, and adjusting your projections accordingly, your vision of the future should become increasingly accurate and reliable.
Consider more than one cash flow
One useful trick is to create three different projections rather than one: a best-case scenario, a worst-case scenario, and a middle-of-the-road option. To produce these figures, you will need to consider how your market is developing, whether new competitors are likely to enter the sector and present a threat, and whether your existing customers are fully satisfied with your product or service.
A few basic mistakes to avoid
So where do businesses tend to go wrong when projecting their cash flow? Here are a couple of pointers. First, many underestimate their costs, particularly for people. Remember to include recruitment agency fees for new team members, benefits packages, office space, and IT equipment, not just salaries and bonuses. Secondly, don’t always assume that you’ll keep all your people–from time to time, key personnel will leave and you will need to replace them.
Above all, be realistic
There’s always a tendency to present the best possible picture when seeking a loan or other funding. Be careful to avoid this temptation. If your cash flow is unlikely to allow you to meet a lender’s repayment schedule, don’t tweak it to fit or opt for the best possible assumptions–that way trouble lies ahead. On the contrary, you should choose a lender whose repayment schedule fits in with a realistic projection.
Finally, always leave yourself a realistic measure of working capital in case things go wrong. Equipment can fail, clients can pay late, and the cost of raw materials can increase. If you don’t have the cash on hand to weather these storms, then you don’t have a viable business.
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