The basis to managing cash flow is to ensure that you measure it – plan for it and prepare.
Cash flow forecasting is an essential management tool, allowing you to understand the peaks and troughs of your business and understanding the affect of seasonal variations, credit policies, and balance sheet transactions.
The three most important things to measure in a business are customer satisfaction, employee satisfaction and cash flow – Jack Welch CEO General Electric.
It’s interesting to note that 2 of those 3 are non-financial KPIs.
Mr Welch is generally acknowledged as one of the all-time great CEOs and I think he’s spot on with this assessment.
You must have a Cash Flow and Profit Plan for at least the next 12 months of operations so that you’ll know:
- How much cash your business will need.
- When it is needed.
- If you will have the cash you need or if you should apply for financing (this process takes time).
- If it’s feasible that a bank or other institution will loan your business money. Creditors require certain base equity capital investments before they will loan debt money.
- Will you have excess funds to place into short-term investment, or long-term asset building.
You’ll then be able to structure your business’ policies for working capital management to meet your cash needs, or work to apply for financing.
Once you have your 12 month forecast you should “roll it over” on a monthly or quarterly basis so that it remains current, otherwise it will be out of date virtually as soon as you have completed it.
Remember, what you can measure you can manage.
Forecasting and Planning your Cash Flow – Step 1, Sales Forecasting
Start the cash flow forecasting process by Sales forecasting.
Look at what products and services you are going to sell.
Estimate the number of units you will sell per item per month.
Decide on the price that the market will allow – based on the value of your product or service to individual categories of clients.
Take into account past sales and profitability of each product line, seasonal effects on sales, your competitors or emerging competitors for each product, and business environmental changes.
Who will your customers be this year? How many clients will return, and how many will be new clients?
How much will each customer buy? How many times will they buy from you? What price should you charge? What is the marketing willing to bear? What are your competitors charging?
This analysis has the added advantage of helping you understand your profitable services/products and customers.
Please consider each product or service separately in order to get sufficient information to make the most educated decisions.
If you have any other income generated, other than by sales – include this also.
Forecasting and Planning your Cash Flow – Step 2, Direct costs of products and services
The next step is to look at the direct costs of your product/service.
Take the number of units which you have estimated in your sales forecast.
Determine the composition of each unit.
Cost each part of all the units.
Take into account what your suppliers are charging. Should you consider changing suppliers, or are you happy with the service and prices of your current supplier?
What additional costs do you incur on each product or service before selling it (ie stock carrying costs).
Forecasting and Planning your Cash Flow – Step 3, Expense forecasting
Look at the different categories of expenditure.
Variable Expenses: Operating expenses that vary in direct proportion to sales revenue.
Activity Expenses: These expenses are essentially variable expenses, but they don’t necessarily vary in direct proportion to sales revenue. They’re driven by the level of activity that goes on in an organisation, which is not always an indication of results achieved.
Fixed Expenses: Those expenses that are independent (at least in the short term) of the monetary value of sales and the level of activity. Very few expenses actually fall into this category, but a good example is rent.
As part of your expense forecasting, some of the estimates and assumptions you’ll need to make may include:
- Will you be hiring new team members? How will that affect other expenses, like office space and phone charges?
- Will you be increasing salaries?
- Are you keeping benefits the same, or introducing new ones?
- What are your estimated tax payments?
Forecasting and Planning your Cash Flow – Step 4, Reviewing the profit
Once you’ve done your revenue and expense forecasting, you need to be sure you’re making enough profit. If not, your choices include one or both of the following:
- Increase your sales
- Decrease your costs (but remember: you can’t shrink yourself to success).
Most importantly, aim high and be realistic. And remember that changes take time and don’t happen overnight—but they can happen with proper planning and KPI monitoring.
Forecasting and Planning your Cash Flow – Step 5, Plan your Cash Flow
Estimate when you’ll be collecting cash. This will be dependant on your level of cash sales and your debt collection policy on credit sales.
Estimate when you’ll need to pay cash out. Look at credit terms of suppliers, discounts offered by suppliers, team member pay day’s.
Plan for any Balance Sheet transactions, such as equipment purchases or improvements.
Determine what fixed assets or asset improvements you plan to invest in during the next 12 months. Determine what fixed assets you plan to dispose of during the next 12 months.
Decide on the distributions that will be made to the owners. Account for any capital funding from investors.
Finally, see how much more financing you’ll need.
Managing the cash flow
Cash flow planning allows you to identify those potential cash crunches, as well as cash opportunities to invest excess cash flow and increase profitability. Two methods you can use to manage and increase the cash flow of your business include:
- Employ working capital management by managing receivables, payables, and inventory. This should be your first choice.
- Obtain financing or additional capital. This should be your second choice, as financing and capital sources cost money—interest expense and financing fees for example. They can reduce profitability, and most importantly, financing is not a guaranteed source of cash flow. Banks and other lenders will require your business to meet its lending criteria.
The good news is that our firm can help you with all aspects of this, right through from planning the cash flow to managing it.
Even out the flow
Another area businesses struggle to deal with are the peaks and troughs in the cash flow. This can cause us to run short of cash in one month and have a large surplus the next. Potential ways to level out these peaks and troughs are as follows.
- Marketing. If marketing is performed prior to a notoriously bad time of year, you have the potential to pull the trough upwards. An example of this would be a gardening business where customers normally spend money when the summer starts, and the weather is more favourable. Marketing that involves information on activities that should be being performed in the garden for preparation for summer can be started early. This marketing can include specials and packages to entice the customer to spend early.
- Work scheduling. Encouraging non-urgent customers to wait for goods and services to a slower time of year can assist not only cash flow, but work flow as well.
- Pricing structure. Increasing prices when there is the largest demand can also assist. An example, are airlines that increase prices during the most busy periods. This can either just increase revenues in the peak months to help you over the troughs, or it will encourage your customers to spend in the trough months.
Measuring your performance
Cash Flow forecasts are useless, unless the actual results are monitored regularly.
Failing to fulfil, or exceeding your assumptions, can affect the long or short-term viability of your plan. Measure and understand the affects of variations to your plan. Remember the business environment is constantly changing, and the same thing that works today won’t necessarily work tomorrow.
There is always the opportunity to be better. If you’re not monitoring your actual results regularly, you can’t capitalize on that opportunity.
The key phrase you need to remember is: What you can measure, you can manage.
Key Performance Indicators
Key Performance Indicators (KPIs) are critical financial and non-financial measures of activity outcomes that indicate, on their own or in association with other KPIs, how a business or process within a business is performing.
In preparing a cash flow plan and profit plan, you make a variety of estimates and assumptions. These are examples of KPIs you may want to review regularly to be sure your business is operating according to plan.
For example, in sales forecasting you estimate the number and types of units (i.e., products or services) you anticipate to sell this year. To get this estimate, you probably determined who your customers would be and how often they’d buy from you.
So one of your KPIs would be the number of customers. By tracking these in a database, we should have fairly accurate statistics each month.
Another KPI would be how many times they buy from you. Only by knowing how often they buy from you can you successfully implement strategy to increase the number of times they buy from you.
Working Capital Management offers several KPIs, including stock turnover, debtor turnover, and creditor turnover.
The success of these KPIs will ultimately determine the success of the Critical Success Factors: Profit and Cash Flow.
You can’t influence profit directly, and influence on cash flow is limited as well. But you can influence many of the items that drive them.
And when you input your actual results every month and compare them to your plan for these measures, you’re doing KPI monitoring.
Monthly KPI monitoring will help you proactively identify both emerging problems and opportunities and ensure that you get the most out of your cash flow plan and profit plan.
Some KPIs may need to be monitored more than monthly, while some may need to be monitored less frequently. The frequency of reporting will become quite evident once the KPI is defined, but the majority of KPIs should be monitored at least monthly.
Steps to developing and monitoring your KPI’s
Here are 4 easy steps to help you get started:
- Determining what needs to be monitored in your business (your KPIs).
- Inputting actuals and comparing them to plan, either monthly or some other frequency.
- Identifying variances to plan
- Taking corrective action as needed.
Each process owner should be responsible for the KPIs related to their process.
Defining KPIs can seem difficult and requires regular review that the right things are being measured and monitored.
But the rewards are substantial because what you can measure, you can manage and ultimately improve. The improvements will grow your business!
Summary
Cash Flow is an essential factor in the ongoing health of a business.
The best way to ensure that Cash Flow remains positive, timely and available, is to have a Cash Flow plan / forecast.
In order to stay in control, this plan needs to be measured and monitored on an ongoing basis so that you can grow your business and manage the business proactively.
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