Subscribe Blog

Sep 04

The power of Cash flows

Posted by James Burn on Tuesday, September 04, 2018

The power of cash flow forecasts

At some point in its lifetime, every small business suffers from cash flow problems. The trick is to think ahead and figure out when these problems are going to arise, so you don't have to unexpectedly postpone a purchase or hurriedly seek out additional finance. This is where cash flow forecasts come in.

To effectively manage your cash flow, all you have to essentially do is use your income and expenses figures to calculate your cash flow figures before they happen. Then you can plan to limit the impact of a cash drought before it arrives, so you can still pay your staff, the tax man and your suppliers.

The importance of cash flow forecasts

Cash flow forecasts are used to predict your business's future financial position for the period ahead, from three months to a year in advance. Your forecast allows you to see what money you expect to be paid into the business and the amount you'll need to pay out. It's a useful tool to help you manage your business more effectively.

If you owned a typical retail shop with high sales over Christmas and Boxing Day, and then the slump after the New Year Sales, your cash flow forecasts would show high income in December and much lower income over the following two months. Your forecasts would also show stock purchased on a 60-day term ahead of the festive Christmas rush in November and December would need to be paid at the end of January and February.

If you racked up record Christmas sales, there might be a strong temptation to splash out and buy that big-ticket item you've been hankering after – but can you really afford it? A quick look at your cash flow forecast will probably tell you that you need to park the thought of a new SUV or [your latest gadget] and reduce your drawings by downgrading your request to Santa for an iPad. Otherwise, you'll have no money left to pay for the stock you sold in December.

If you're more pragmatic and less inclined to impulse spend, your forecast will also be able to tell you if you'll generate enough profit to cover the costs of refurbishing your store or any other major business decision that you planned to do.

Say your forecast sales figures for March and April will be down on previous years, as a result of continued low national economic growth, the global financial turmoil or the arrival of a new competitor in the market. You might need to arrange short-term finance to tide you over or find ways to increase sales to cover your monthly overheads and operating costs.

In summary, your cash flow forecast gives you a future view into your business finances. It helps you identify cash flow problems before they show up and allows you to make informed business decisions.

How to create a cash flow forecast

You can use Xero and  a spreadsheet program such as Excel, or download a cash flow forecast template to calculate your cash flow forecast. Xero will be able to pull up many of the figures you need to put into your forecast directly from your accounts, saving time and effort.

The hardest part of creating a cash flow forecast is working out accurate income and expense figures for the months ahead. Obviously, the more accurate these figures are, the more accurate your forecasts will be (and the business decisions you base on them).

For your forecasts to continue to be of use, you need to update them based on your actual business performance each month. Replace your forecast figures with the actual figures for the month and make adjustments to the next few months' forecast figures if it appears, based on reality, that your projections were either overly optimistic or pessimistic.

Putting your forecasts to use

Apart from giving you a fairly good indication of your likely cash position at any point in time in the year ahead and alerting you to potential cash flow problems (which enables you to act in advance, rather than react), your cash flow forecasts can be used to model your future plans.

Let's say you plan to expand the business, by employing a new staff member. You can put the additional expenses into your forecasts to see if you can afford the new staff member, and then add in the additional income you expect to receive to see the overall effect on your business.

You can run three versions of this forecast: a worst-case, best-case and middle-of-the-road scenario to see how this will affect your business finances. These forecasts will help you decide whether to employ a new staff member or not. If you're uncertain you'll achieve your best-case sales and your middle-of-the-road figures don't look that promising, you might decide to wait a year before you employ another staff member or expand the business.

Alternatively, you might discover it's better to use any surplus cash to pay off debt.

Once you have your forecasts set up, use them to model “what if” questions about your business to help you make the best decisions for your business.

If you are stuck with any of this we are only a phone call away - contact James at james@jba.net.nz or 021 203 5348.