Dubai: A cash flow forecast is a vital tool for your business because it will tell you if you'll have enough cash to run the business or expand it. But how often do business owners put it into practice?
“While cash flow forecasting may sound like a smart idea every business should implement, you might be surprised how many don't,” explained GCC-focused serial entrepreneur Saad Mashoud.
“As the owner of a business, cash is the lifeblood of your business. Whether you’re profitable or not, you always need to stay on top of your money.”
Forecasting cash flows isn’t easy
However, regularly modelling cash flow isn’t easy, so many business owners look to simpler metrics to help them grasp their cash situation, adjust optimise finances, and plan.
Most often businesses have no formal cash flow forecasting process in place to plan for and manage the short-term excesses and shortages (also known as peaks and valleys) of cash flow that is experienced.
“Regardless of what accounting software you use, it is often best to start your forecasting efforts in a spreadsheet and then try and automate the process with software,” Mashoud added.
Cash flow forecasting still proves useful
Still, the most reliable way to understand your cash flows, predict your future bank balance, and see how your finances would react in best- and worst-case scenarios, is to build a cash flow forecast.
Building a cash flow forecast is a lot more complicated than calculating other metrics like cash ‘runway’ or ‘buffer’ (explained below), but it’s also significantly more accurate and useful for decision-making.
A good cash flow forecast takes historical trends into account, but it also incorporates your own assumptions about the future, like changes to headcount, revenue growth, funding, etc.
Cash runway shows them how much longer firms can operate before they’re either out of business, calculated by taking your current bank balance divided by your monthly cash burn rate.
Cash buffer gives business owners an idea of how long their business could survive in a worst-case scenario – if they completely stopped generating revenue.
Here are the three key expert secrets to accurately forecast and maximise the cash flow of your business.
1. Study cash flow weekly for at least 90 days into the future
It is usually appropriate to look at cash flow on a weekly basis — usually as of the last working day of each week. It should also extend, by week, at least 90 days and as many as 180 days into the future.
“Depending on your needs, between 90 and 180 days is usually sufficient for short-term cash flow,” opined Ravi Meitri, an independent business consultant based in the UAE.
“It is important to compare the actual cash flow results from each week to your projections to improve your assumptions each week.”
2. Calculate cash flow forecasts based on collections by customers
Now that you have the timeline and frequency handled, you need to look at your cash inflows, which primarily come from customers, explained Meitri.
“Determine how long it takes to collect from each customer (if you have less than 50 total customers). If you have more than 50 customers, then you need to separate your customers into payment classes such as credit card sales, cash, and so on.”
Schedule out when you are expecting payment, by week, for each of your existing dues, and based on your sales projections, project subsequent collections for the duration of the forecast, he added.
“Often the best way to do this is to look at weekly sales for the prior few years and project based on growth factors for each customer or customer class.”
3. Keep variable and fixed cash outflows separate
It is almost always easiest to separate the variable from the fixed expenses by your vendor (or clients) and their type, separately.
“The variable expenses will be driven by your sales projections and the terms with each of the vendors in this category,” Meitri further noted.
The fixed outflows include all cash fixed expenses plus debt payments and regular distributions to business owners, if there are any.
“You may need to separate the variable and fixed portions of payroll and salaries, but you need to make sure they are included.”
Key takeaways
Why go through all this effort to understand your short-term cash flow? Among many other reasons, so you can see in which weeks your cash flow will become negative, how long it will stay negative, and by how much it will go negative in each of the ‘valleys’ in your cash flow cycle, experts reiterate.
“If the cash flow is only negative for a week or two, then you can likely handle it by slowing down your payment of payables or through some other tweak,” said Mashoud.
“If it is longer than a few weeks, then you need to plan for how you use other sources of financing to bridge the ‘valley’ (explained above) until cash flow recovers.”
Not knowing what will happen to cash flow at least 90 days into the future is a great source of anxiety for most businesses, surveys reveal.
Conversely, having an accurate projection of cash flow that is updated each week removes the anxiety of the unknown and empowers the business to solve any problems or issues before it is too late.
“In addition to manoeuvring through the ‘valleys’ of cash flow, it is almost as important for a business to manage its excesses, or peaks (explained above), as well,” added Mashoud.
“Whether it is merely implementing a money management solution to earn some interest or to know that the business has enough cash make a critical expenditure, forecasting cash flow will empower any business to manage and plan for its most vital resource — cash.”
