by Anne Moore Odell
Like blood beating through the heart, cash flows in and out of a business. Cash flow is not profit. Rather it is the money coming into the business through sales and other revenues and it is the cash leaving the business, for example, as paid invoices and payroll. Cash flow, or cash on hand, is simply cash in minus cash out.
Cash flow forecasting, then, is the process of looking forward to what you expect your cash flow to look like over a set period of time. The period can be for a month, 12 weeks, or even as long as a year. It is an extremely useful tool for businesses as it can provide insights to improve profitability. If management has a well-constructed cash flow forecast for the year ahead, it is in a strong position to plan, execute and control improvement measures.
“Forecasting cash flow helps businesses be realistic rather than idealistic”, says Jack Koester, a Counselor affiliated with SCORE(r) Lake/Sumter Chapter 414 in Florida. “Cash flow forecasts are tedious and require substantial due diligence. But survival is the main early benefit. It always has been, but it is much clearer today.” SCORE(r) provides free online and face-to-face business counseling, mentoring, and training.
Creating a Forecast
A cash flow forecast is a written document that makes note of all the cash that you expect to receive and all the cash that you expect to pay out over a given period. Plan for when you will receive payment on invoices so that you can efficiently time your payments to vendors. To be useful the forecast needs to be updated frequently, honestly, and in the current economic times, conservatively.
There are many programs available to help with cash flow forecasting, but one of the best is one that your business probably already uses daily: Excel. “An Excel spreadsheet allows you to create a forecast that matches the size of your organization, the inflows and outflows,” says Mike Iverson, CEO of Trillium Financial. These types of models can be effective ways to measure near term cash flows such as a rolling thirteen week plan.
For businesses interested in a cash flow software program, one provider is PlanWare. Says Brian Flanagan, Director, PlanWare.org, “The simplest solution is to develop a cash flow forecasting plan using a spreadsheet. This can be a do it yourself worksheet or based on a template located on the internet.
Another option is a full software program that you can purchase such as PlanWare’s Cashflow Plan. It offers a range of forecasting planners some of which are integrated into your budget planning which includes a balance sheet, profit and loss statement, and a cash flow statement. The benefit of the full software program is a change in sales automatically adjusts the cash inflows from receivables and values for cash and receivables in the balance sheet based on your assumptions. These plans can be effective for longer range planning such as over a 12 month or longer period.
Cash Flow Forecasting in a Recession
“Many more companies are generating cash flow forecasts today. Cash is always an issue, even in good times,“ says Iverson. “I have more clients that forecast 12 weeks out, especially now. Cash flow forecasting for the next 12 months can be more difficult.”
Iverson adds, “With ever larger, more seemingly secure companies declaring bankruptcy, asking for extended terms, and making slow payments, cash flow is definitely trickier than it has been in years past. Making it even more important to do.”
“If we feel clients are being too optimistic, we strongly suggest they project a separate set of cash flow projections based on a WORST CASE scenario. Sobering!” says Koestar.
“More of your Fortune 500 or Fortune 2000 companies are using cash flow forecasting. Typically, they don’t have a huge need to forecast cash short term,” Iverson adds. “But companies are making sure that they are going to have cash and capital, regardless of their size, forecasting more frequently and in shorter time frames.“
“In buoyant times, businesses were reasonably sure that cash would automatically follow on from profitable trading,” says Flanagan of Planware. “This allowed firms to gear up and pursue higher sales without worrying unduly about getting paid or securing additional credit for working capital purposes.“
Flanagan continues, “The downturn has changed all this and the key issue has become the maintenance of cash flow. This is, in many senses, more important than profitability as more businesses fail because they run out of cash rather than generate losses. Cash flow forecasting has become critical in two areas. First, short-term planning for receivables, payables and inventory to ensure that working capital (cash) is managed effectively. Secondly, medium-term forecasting, e.g. for 12 months ahead, so that firms can anticipate cash flow problems.”
Forecasting cash flow is always difficult. The recession has exacerbated this because it has disrupted established trends and patterns. However, when forecasting during a recession, Flanagan has two suggestions: First, concentrate on higher-level forecasts as these can be just as accurate or possibly more accurate than very detailed projections. Second, make forecasts based on alternative scenarios, for example, “most likely case” and “most probable worst case”. Aim to hit the former but take actions that presume the latter will occur.