Understanding and Projecting Cash Flow

Relationships and businesses are like sharks. Both need to keep moving—and continually improving—to remain alive. When it comes to business, two ways to keep moving forward include: looking at relevant KPIs to focus on what needs to improve and; forecasting when you might have cash gaps in the future.

The importance of understanding your cash flow

A common, unfortunate question often asked of our small business clients is: Why are my sales booming and margins look OK, yet I am scrambling to pay vendors?

Cash flow equals survival for all businesses. Even businesses with great profit margins can fail if cash flow is not managed correctly. Successful businesses need to pay attention to each facet of cash flow, not just daily bank balances. Some metrics to review include:

• Are you collecting cash from your sales quickly enough?
• Are you efficiently using opportunities to stretch out paying for expenses?
• Are you timing payments to owners wisely?
• Are you using resources in the best way to bridge the gap during operating shortfalls?
• Is your cash falling to the bottom line according to your goals? How about when compared to similar businesses?
• Is your inventory sitting on the shelf for too long?
• Are your total fixed costs exceeding what most comparable businesses are spending?

Raw data and standard financial statements are part of what you need to evaluate where you are headed. Ideally you will use a system that creates clear, readable signals that you can trust, and ideally you are able to see those often. Depending on your line of business, quarterly is the minimum period for evaluating these metrics.

Don’t fly blind: Map out your year-to-plan for gaps in cash flow

Using financing sources other than cash on hand is often a good strategy, but a healthy business does this according to plan, not when it is unpleasantly surprised by shortfalls. Many businesses experience seasonal cycles of being flush versus having to draw on a line of credit. Mapping out those expectations in the year ahead can help a business to create the most efficient strategy when using those funding sources, avoiding higher risk areas and avoiding missed opportunities.

• Using a flexible budget that adjusts for current events is a great place to start. From this you can jump off into a more realistic cash flow forecast.
• Adjust for realistic timing of how your business collects sales and pays bills. Start with when you will earn and incur expenses (accrual basis), and then push those figures out by how long you normally expect to collect on sales and pay your expenses (cash basis).
• Incorporate financing and investing activities you are already expecting like owner infusions of cash (or vice versa) and large equipment needs. These are not included on a standard profit and loss budget so may get overlooked.
• The more “big picture” the process becomes, the more likely this will get completed on a regular basis. Be realistic and make it a habit to get budget goals added to the calendar.
• When creating forecasts, consider using a tool that has been vetted and integrates well with your accounting software or is included in your accounting software. Manual entry and complicated spreadsheets lead to errors and frustration.

Many businesses have an annual budget on the to-do list. However, making that budget flexible throughout the year and incorporating a cash flow element is what really brings your budget to life and benefits you in a real way.

Finding the right tools—and the right team—to help you create this process and understand the results will be key to your success.

For additional considerations, please reach out to Ruth Lott, Director, or contact the Business Solutions team at Mahoney to be of help to you in any way.

Looking for more accounting and bookkeeping tips and best practices information? Here is a blog on how to develop a solid accounting foundation with your chart of accounts.