Avoid cash flow catastrophes: Part II

Cash flow forecasting 101

Forecasting a business’ cash flow is critical to ensuring operations can continue without major disruptions. But one way you can tell that cash flow forecasting is a pain point for many people is the number of templates and software solutions that are available online. 

Nevertheless, David Douglass, a partner with Atlanta-based professional services firm Tatum, says you can also start developing your cash flow forecast simply, by thinking about the forecast the way you would a personal check register.

He suggests listing your sources of incoming cash, such as:

• cash sales to customers

• sales on credit to customers with specific payment terms

• borrowings from lenders

• investments from owners.

Then, you should list the known, recurring reasons for cash going out the door –things such as payroll, taxes, rent and payments to vendors for raw materials. 

“For both cash inflows and outflows, start with the big items first and work down to smaller amounts,” Douglass says. “Be specific in noting the week, or even the day of the week, that disbursements are made.” 

For example, you may pay employees on Friday, but the cash to cover payroll, including taxes, medical premiums, 401k contributions, etc., might need to be in the bank by Wednesday.  At the same time, if you pay vendors by check and mail those on Friday afternoon, they may not  “clear your account” until the following Tuesday or Wednesday.

Douglass says some of the templates or Excel spreadsheets online might be helpful. But, he says, “They don’t eliminate the need to think carefully about your specific company – each is different,” he adds.

In later posts, we’ll cover some of the ways each company is different in terms of how cash flows into and out of the business, and that may give you some ideas for specific areas of interest to your business. But at least initially, don’t get too hung up on a lot of detail in your forecast.

“Pick a level of detail that is relatively easy to develop and maintain, and then refine the forecast as time goes on and you get better at forecasting,” Douglass says. 

Your current cash cushion should also determine how much detail you use at first. If you don’t have much cash, you’ll need to be more detailed and accurate, he says.

Michael Voie, a CPA and partner with Stallcup & Voie LLP in San Francisco, says that if you’ve got the equivalent of one month of expenses in the bank, you should probably think about taking a closer look at your cash flow forecast often. But if you’ve got six months of expenses covered by your bank balance, your time might be better spent focusing on some other aspect of managing the business than on more frequent cash flow updates. “It’s kind of a balancing act,” he says.

Rebel Cole, professor of finance at DePaul University, notes that popular accounting software programs such as QuickBooks often have built into them the ability to generate a cash flow forecast, but you also can generate your own forecast using a spreadsheet, with each column representing a day or a week, and then rows representing cash inflows, outflows and the cash balance. 

More advanced forecasting tools let you experiment with “what-if” scenarios—what happens to your company’s cash and financial position if sales increase by 20 percent? If you purchase this piece of equipment for $X but expect it to generate an additional $Y in revenue? These advanced solutions are a great help for contingency planning, in which you can think through possible reactions and outcomes. 

Next in the series: How often should you update?