Cash Flow Forecasting: Plan for the Best but Prepare for the Worst

By Lori Murray, Manta Contributor

If you’re not convinced that cash is king, consider this common scenario: A small firm, already working through a steady flow of business, decides to take on a large project. To make it work, they need to hire a couple contractors to help with the additional workload. Unfortunately, paying those individuals could be a challenge, considering the company won’t start to collect any of its fees for at least 60 days. Unless there’s enough cash on hand, taking on the new business may be more of a problem than a reason to celebrate.

“I have seen businesses grow themselves into bankruptcy. They weren’t able to make payroll because their clients didn’t pay in an anticipated fashion,” said Ken Walsleben, assistant professor of entrepreneurial practice at the Whitman School of Management at Syracuse University. “Growth puts a strain on cash flow. The more accounts receivables you have out there, the more demands you have on inventory and paying your people. You may not get cash for 30 to 60 days, and growth exacerbates that problem.”

Planning is key, but not everybody does it. “There’s a lot of discussion about cash flow, but 70% to 80% of businesses either don’t do it or do it minimally,” said George Cloutier, founder of American Management Services in Orlando, Florida. “But no cash flow means no business, and poor cash flow means no business eventually. It’s like the Titanic. If you don’t see the icebergs, you’re done.”

Putting a Plan in Place

When managing cash flow, small business owners need to plan for the best but prepare for the worst. “Having a budget helps you map out a minimum of six months, and best-case a year, of your expected cash flow—what you expect to come in and what you expect to come out—in addition to the minimum you should have on hand,” said Denise O’Berry, small business expert and author of Small Business Cash Flow: Strategies for Making Your Business a Financial Success.

Unfortunately, many small business owners equate cash flow with doing math. “It’s not about math; it’s about the story of your business—the successes, the failures, what’s going well and the things you probably need to dump,” O’Berry added. Appropriate cash flow planning makes it possible to adjust to the peaks and valleys along the way.

Here are some tips to help you get started:

  • Understand how your business generates cash. Retail businesses get cash or credit card payments daily, so their cash conversion cycle is shorter than a business-to-business service where payment may not occur for weeks or months. In the latter situation, you may need to work out a payment plan with your supplier. “All businesses have a degree of seasonality and a lack of predictability,” said Ted Zoller, T.W. Lewis clinical associate professor of strategy and entrepreneurship at the UNC Kenan-Flagler Business School. “Understand what’s specific to your industry so you can achieve your goal of a predictable revenue forecast.”
  • Know the difference between profit and cash flow. If you sell $1,000 worth of widgets, for instance, and the payment terms are net 30 days, you have $1,000 worth of sales and a profit. But although your financials indicate that you are comfortably profitable, you may not be able to pay your bills. That’s because you haven’t been paid.
  • Monitor the core metrics of your operations. Know what drives revenue (receipts) and what drives costs (expenditures) in an effort to keep your cash flow strong. This will help you achieve a predictable and sustainable margin in your business.
  • Be realistic about your forecast. Many small business owners are overly optimistic about the amount of cash they’ll be taking in. There are ways to solve cash flow shortfalls, but you first have to face reality. It might help to work with someone who is totally objective about your business.
  • Do it yourself. As the business owner, it’s your job to manage your cash flow and profit-and-loss statement. This is not a function you should delegate. “The insight you get to build the business comes out of that data,” Zoller said. With that in mind, however, don’t spend your time setting up the accounting system or managing the taxes. That’s the responsibility of a good bookkeeper.
  • Do it on a regular basis. Most experts recommend monitoring your cash flow on a weekly basis, and creating a profit-and-loss statement every month. Determine what bills you need to pay and how much cash you expect to take in. If the cash is not coming in, you will need to delay the payment of liabilities. The weekly process requires constantly changing and tweaking the data.

As a small business owner, you understand the importance of planning. Apply that philosophy to cash flow forecasting so your business can grow—without taking on the added strain of cash flow shortfalls.