The Importance of Cash Flow Forecasting

New Zealand business owners are relatively familiar with their profit & loss (P&L) statement and balance sheet as tools to manage their business, however many will be surprised to know that they’re missing out on vital information.  What the P&L and balance sheet isn’t able to tell you is where the cash has gone or where it will be going – and that’s why a Cash Flow Forecast is one of the ‘big three’ statements that every business should be monitoring. 


What is a Cash Flow Forecast?

A cash flow forecast takes your opening position and uses a budget to show how money will come in and out of your business.  Money will be banked from sales and collecting debtors or perhaps even from selling assets or drawing down a loan.  In contrast money going out will include typical business expenses, and funds withdrawn by you as the business owner but also those irregular lumpy payments such as GST or tax.  Mapping money in and out of your business will help you to identify if your business will run out of money in advance of it happening.  A comprehensive forecast should always include:

  1. Budget
  2. Cash Flow forecast
  3. Forecast balance sheet 

These big three statements help business owners to understand where their business is going and also what the it might look like financially when it gets there.  


How Cash Flow Forecasting Helps Business Planning

A cash flow forecast is merely intel which has extended value if you can dedicate the time to understanding the story your cash flow forecast is telling you.  In order to do that business owners need to get intimate with their business processes, activities and behaviours that help and hinder converting profit into cash.   Most people have heard the term ‘cash is the life blood of any business’ and a ‘vital nutrient’ for achieving growth, however simply making a good profit does not mean that a business has the cash it needs to survive or grow. Typically business owners preparing a cash flow forecast will spend time getting a good handle on the relationships between collecting debtors, investing in stock and paying creditors, often hitting a bump in the road when this cycle of cash doesn’t produce the outcome they expected or need.  This can be confronting especially if its your first time preparing a cash flow forecast.

For most business owners their expertise is not financial advisory, so don’t be afraid to partner up with someone that will help you through the process.  A Financial Advisor can help you to influence your cash flow and change the outcomes by getting down to the root cause.  Too often symptoms of poor cash flow are treated by accessing debt or personal funds, both of which will likely only temporarily relieve cash flow pressures. 


Improving your Cash Flow Results

Changing the outcome of a cash flow forecast requires identification of the challenges your business is facing.  While each business will have a unique set of challenges there are a number of causes of poor cash flow that are more common than most.

  • Inappropriate debt – A common cause of low cash flow is that the debt the business holds and the structure of the debt produces payments that are higher than operational cash the business generates, making the debt unsustainable.  The challenge maybe as simple as having too many separate debt arrangements which can easily be consolidated or possibly the length of time to repay the principle is too short. 

  • Inventory – Investment in inventory can be a sizable figure which is why understanding how quickly your inventory is being sold is a key business process to comprehend.  Inventory turnover is an area where there can be a disconnect between the profit in a budget and the asset in the balance sheet – if inventory is held to long it means that your cash is tied up and your money is not being used as efficiently as possible. 
  • Collecting Accounts Receivable – When customers don’t pay by the due date you’ll be required to draw on cash reserves to meet operational business payments.  It’s easy to focus on generating sales and working in the business, however collecting debt is a task that is often under prioritised resulting in less cash in the business.
  • Owner remuneration and cash drawings – a Financial Advisor assisting with a cash flow will always review the accumulated amount of cash paid out to owners of the business.  This is done to better understand the amount paid to owners relevant to the ability the business has to sustain the payments.  Owners drawing too much cash from a business is a common cash flow symptom which places limitations on a business’s operation.  Planning to address this challenge is vital to supporting business growth.
  • Unsustainable growth – Growing your business is a great way to increase profits, but profit and cash flow are not the same things.  In fact, rapid growth can hurt cash flow when the rate of growth creates large outgoing payments.  Businesses in a high growth phase or rebound phase will need to be very familiar with their working capital because this is what will fund growth.  The debtor, inventory and creditor cycles will have material impacts on the amount of working capital.
  • Margins – The gross profit is what’s left after deducting variable items such as stock, materials and labour.  Cash flow issues can arise when gross profit margins are too low which means the underlying cause needs to be investigated; are the variable costs too high or sales too low?
  • Overheads – Every business should complete a thorough review of its expenses every year.  Not with an idea of simply cutting them but instead to make sure that business spending is adding value. 
  • Tax Obligations – Lumpy GST and tax payments have a significant impact on business cash often causing stress when payments are due.  Tax payments should be monitored during the year relative to how the business is performing.  Striking a balance between keeping cash in the business and using flexible tax payment options helps to ensure sure that cash is being utilised as efficiently as possible. 

There are numerous causes of poor cash flow and these are just a taste of what might a business owner might encounter when preparing and analysing a cashflow.  Partnering with someone that can support the cash flow process can make a difference to how difficult the forecasting can be, especially when a business will probably have multiple causes limiting cash flow.


Getting the most out of your investment

A good cash flow forecast is an investment that business owners use annually as part of their business planning, however the most successful business owners take it a step further by loading it into their accounting software to use as a monthly tool. 

Tracking your business’s progress and measuring goals increases accountability.  For many business owners this can be a daunting or confusing process but it’s not something anyone has to do alone.   Consider working with an independent person or financial advisor to discuss your financial results at regular intervals during the year.  They will help you understand the big three financial statements and work alongside you to develop measurable goals to ultimately produce more cash and greater efficiency.

Contact BDO today to learn more about financial forecasting for your business!