Cash flow is the life-blood of almost all businesses. Without cash, businesses can’t pay employees, suppliers, taxes, debt or insurance. A shortfall in cash flow can result in a crisis of liquidity and ultimately can lead to insolvency. That is why it is vital for businesses, especially start-ups, to have a cash flow forecast
A cash flow forecast is essentially an early warning system for businesses to manage their cash flow and is an essential discipline for companies of all sizes.
While cash flow models vary greatly in complexity, most SMEs and start-ups start with a simple spreadsheet. Using the annual operating budget as a starting point, a business should weigh its anticipated income against its anticipated expenditures to arrive at each month’s cash flow. These anticipated figures can be built on historical data, although for start-ups there is often an element of educated guessing involved.
The model should be amended weekly or monthly to reflect actual figures. Once an accurate model has been built an organisation can accurately predict its cash flow and anticipate cash flow deficits.
Managing a cash flow deficit
An accurate cash flow model will give an organisation the necessary time to plan for cash flow deficits. A deficit occurs when payments are due and the cash balance is too low to meet those payments. It is important to note that this does not mean that the company is running an overall deficit, but rather, that at a specific point, it does not have the cash available to service its obligations.
With payroll, taxes and insurance needing to be paid on time, this is where a line of credit can come in use. Credit can help to smooth out the fluctuations in a company’s cash flow.
Just as cash flow management allows businesses the luxury of forecasting and planning for deficits, it also allows them to anticipate a cash flow surplus.
When operating in a cash flow surplus, organisations may wish to consider either paying down lines of credit or making short-term investments, which can add interest income to their bottom line.
As the business grows, so too does the model
As the business grows in complexity, there will come a time when a basic spreadsheet will probably not suffice to provide accurate forecasts. Many organisations find themselves tagging erroneous rules onto the spreadsheet and before long, they become complex and brittle.
When a model gets to this stage, companies have historically bought an off-the-shelf solution or brought in a developer to design a bespoke piece of software to handle the forecasting. Until recently, these have been the only ways to remedy over-bloated spreadsheet models; however, the proliferation of cloud technologies have now opened up new possibilities for companies. By taking advantage of software as a service applications, companies are now able to tailor cutting edge software to their needs in a cost efficient manner.
Regardless of where a company is in its life cycle, there are a host of tools out there that will allow them to accurately forecast their cash flow.