Small business essentials: the importance of cash flow forecasting

2 years ago

Even a successful small business can go to the wall frighteningly quickly without proper management of cash flow. We look at why cash is king in the business jungle.

You founded your business on a great idea, and you execute on that idea superbly.
But to stay successful, there’s one more critical thing you need to do: get on top of cash flow before it gets on top of you. It’s the reason companies with perfectly respectable paper profits can plunge into bankruptcy. Why?

More customers = more complexity
The quick answer is that running a business, even a very profitable one, costs money. You might be seeing growing sales and happy customers, but you’re also spending on materials, staff and premises while servicing finance. When businesses grow, they quickly become more complex. This complexity makes it more difficult to see the cash position now, and forecast what it will be in weeks’ and months’ time.
When you have just a few customers, keeping on top of their payments is fairly easy. You can do it in your head. But if you have hundreds of customers, who’s checking when they will all pay? Do you know if they’re paying late? Is anyone chasing them for payment?

Manage spend wisely
The same applies to spending. Understanding cash flow is critical when working with suppliers. You need to understand how many suppliers you have, what you pay them, and when. For example, do you spend more with a supplier to get a high-volume discount on materials, or keep hold of cash and buy in small amounts at a higher price? It’s impossible to make these decisions without knowing and forecasting your cash position.

Timing capital investments
Meanwhile, growing businesses require more capital. At some point, if you’re ambitious, you’ll need to make some big decisions. When do you need larger premises? When do you need a bigger IT system? If you’re making things, do you need more machinery? Do you need to hire more people? You’ll need to make these investments if you are to keep your customers (and your employees) happy. Crucially, you’ll need to do so before they pay you. And it would be suicidal to do so if you don’t understand the cash position of the business, now and in the future. Remember you’ll also need to keep the business running day to day, spending on bills, taxes, small items, travel and rent.

Don’t lose sight of cash
Small business owners are often very focused on gaining new customers and satisfying the ones they have. The problem is, if no-one is focusing on liquidity, things can go wrong very quickly. If two customers fail to pay substantial invoices in the same week you settle a big supplier bill, you have to hope the bank will extend your finance. If it doesn’t, you could be in trouble. It’s worth repeating that this frequently happens in otherwise successful, growing businesses – and often causes their downfall.

Get a cashflow forecast in place
Accountants will tell you that cash flow problems rarely occur out of the blue. The chances are the warning signs have been there for a while, but no-one has noticed them.
The vital question is: do you know what your cash position will be in six months’ time? If not, you may struggle to cope when things go wrong. If you can forecast that far forward, and it doesn’t look good, you still have time to put in place a strategy to make it through the difficult growth period. And it’s important not to confuse the bank balance with the cash book. Managing the business from the bank balance is like driving a car by looking only in the rear view mirror. You’re seeing what’s gone past, not the pothole you’re about to hit. A good cashbook will lead to better forecasting.

The right tools can help
The tools for efficient bookkeeping are getting easier to use and are available, via the cloud, on a pay-as-you-go basis. Conquering cash flow won’t hold you back; it will be a catalyst for driving the business forward. Doing it proactively is more efficient than firefighting, and gives you more time to spend with customers and keep the business growing.

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