Cash flow is often referred to as the lifeblood of every business. As an entrepreneur, your business can endure plenty of blunders. Unfortunately, cash flow isn’t usually one of them. Failure to manage cash flow typically ends one way—business closure.
Poor cash flow is marked by owing more than you can pay. Sure, you might hit a rough month (or two) and need financing to cover cash flow gaps, but consistent failure to make more than you spend should be a fluorescent-red-flashing alarm. But don’t panic! The solution could be as simple as fine-tuning your cash flow forecasting.
What Is Cash Flow Forecasting?
Cash flow forecasts are educated projections about the money you will pay and receive. Forecasting your cash flow helps you identify financial gaps and opportunities while there’s still sufficient time to respond. If you foresee a seasonal slump, you can go ahead and secure a business line of credit. Or if you expect a big bump in revenue, you can plan how you’re going to reinvest that cash in the business.
Failure to forecast cash flow or incorrect projections will jeopardize your business. You may run out of inventory before you have enough cash to resupply or you might not have enough money in the bank to pay your employees at the end of the month. Scary, right? It doesn’t have to be. You can avoid situations like these with simple, accurate cash flow forecasting.
How to Forecast Accurate Cash Flow
Every small business owner should know how much cash they have on hand—and how much they’ll have at any given point in the future. To make your projections pinpoint accurate, you’ll need to hone a few financial skills:
1. Regularly Check (and Understand) Your Financial Reports
Bookkeeping software, like Sunrise, makes creating and viewing your financial reports a click away. Make it a regular habit to analyze your profit and loss, balance sheet, and cash flow statement. By staying up-to-date on these financials, you’ll always know where your business stands.
Checking and understanding your financial reports are 2 different things. Make sure you comprehend what each statement is telling you and how to make decisions based on that information. For instance, you may look at your profit and loss statement and confuse profit for cash. They’re not the same.
2. Estimate Your Receivables Cycle
With your financial reports in hand, you’ll have reasonable projections for how much revenue you’ll make each month—but do you know how long it’ll take for your sales to turn into cold, hard cash? Sometimes it takes clients weeks or months to pay the bills.
Accurate assumptions will help you avoid cash flow gaps. Knowing when you’ll expect payments will help you decide if you need to secure account receivable financing or if you can wait it out.
3. Dial-in Your Budgets
Don’t look at your budgeting as a one-and-done ordeal. Regularly evaluate your cash flow to make sure you’re on track to hit your metrics. If unexpected expenses pop up, you may need to postpone resupplying your inventory or reschedule a planned renovation.
Yes, it’s important to make monthly and quarterly budgets, but don’t hold yourself strictly to those estimates. Frequently check in with your budget and make changes to keep your cash flow positive.
4. Expect the Unexpected
Most cash flow forecasts fail when it comes to unexpected expenses. Business owners nail revenue forecasts and cost of goods sold, so the gross profit estimate is usually spot on, but the projections fall short after that.
You need to factor other necessary costs into your forecasts—salaries, repairs, marketing, rent, etc. These are obvious examples, but the not-so expected expenses are the ones that really trip up cash flow forecasts. Make sure you keep in mind the following variable expenses:
- Months with 3 payrolls
- Increased taxes as a result of increased sales
- Months when premiums are due
Even when you go to great lengths to cover all your bases, unexpected expenses will still creep up on you. That’s why it’s important to budget a cushion of cash each month for “other expenses.” At worst, you’ll have money on hand to deal with any unforeseen costs. At best, you’ll put a little extra money away for next month.
You Have Accurate Forecasts—Now What?
Don’t wait until the end of the year to create your next 12-month forecast. Continue to check back in with your projections and reevaluate. At the end of each month, add another month to your forecast so that you always have an up-to-date rolling 12-month plan.
By following these 4 best practices, you’ll be better able to forecast your cash flow with spot-on precision. Will it always be perfect? No—especially when you’re just getting started. As time goes on, you’ll recognize trends in your business and the industry and fine-tune your forecasts. Once you’ve mastered cash flow forecasting, you’ll have greater control of your finances. With greater control of your finances, anything is possible for your business.