Cash flow is sanity

The saying rings true: Turnover is vanity, profit is reality, cash flow is sanity. With looming deadlines, urgent customers, growing priorities and narrowing margins robbing you of your sleep at night, I know how far down ‘proper’ financial management is on your list of things to do. For entrepreneurs, financial management seems like a luxury afforded to more-established businesses, and definitely not something we need to apply in the early days of business start-up.

Flat-line or life-line?

Everyone has heard the stats on failure rates of young businesses, and been duly alarmed. “Surely the maths is simple,” I hear you say. “Mix a good product or service with a tenacious and driven entrepreneur and the outcome should be glorious success. Right?” Unfortunately, no.

Flat-lining due to cash constraints ranks among the highest reasons for closing down a company. Do all companies that go bust have sub-standard product or service? Not necessarily. It’s simply a question of cash flow; when the cash in the bank runs out, and all funding life-lines have been exhausted, it’s game over.

How can this be avoided? The answer, thankfully, is simple: Proper cash flow management. Let’s look at two major parts of cash flow management: cash flow analysis and cash flow forecasting.

Cash flow analysis

Cash flow analysis is the study of a business’ cash inflows and outflows per cycle, with the goal of ensuring adequate cash flow for business operations. In human-speak: Is what’s coming in enough to cover what’s going out over a certain period of time?

Entrepreneurs need to take the time to analyse and understand all streams of inflow and outflow during a given period.

  • Invoicing a project or making a sale, although it is an accounting profit, does not mean an inflow of cash. Money only enters the bank when the debtor pays, or when the contract is completed and paid for.
  • The timing difference here could be critical when invoicing and receipt of debtors are months apart.

Cash flow forecast

The best way to obtain a better understanding of your business’ cash flow would be setting up a cash flow forecast.

A cash flow forecast predicts the net cash flow of a business over a certain period; the result being the estimated bank balance at the end of each period. In human-speak: Forecasting predicts when shortages or excesses of funds will occur so that you’ll be prepared for them.

With this tool you can develop a financial plan which, if followed, will provide proper cash flow management. Building a cash flow forecast for your business does not need to be rocket science:

  • Use a simple Excel spread sheet with line items for each stream of inflow and outflow.
  • Break each month’s cash flow up into the underlying line items.
  • Monitor your bank balance at the end of each period over a period of a year.
  • Take note of the various flows month to month as well as the month-end expected total.

This gives you a great overview of your cash requirements and allows you to identify risk periods in order to prepare for them.

Guidelines for your forecast

  1. Don’t thumb-suck your numbers. Each line item must have a sound underlying assumption to base the figures on.
  2. Substantiate your figures with either: a. The previous years’ figures that have been adapted for inflation or activity, b. Inputs from experts, or c. Actual quotations.
  3. For income streams, a proper market analyst and marketing plan may need to be consulted in order to obtain reasonable forecasts.

Why forecasting makes sense

Any investor and financier will look at your cash flow forecast for the next five to 10 years before signing on the dotted line. Plus, it is a great tool for managing your company’s finances in order to mitigate risk. So there you have it.

I’ve given you the guidelines you need to set up your cash flow forecast, so you can monitor that bottom line and cash in the bank.

* Louw Barnardt is MD of Outsourced CFO, a financial consulting business tailored for start-ups and SME’s to help them understand their business financial needs. Visit www.outsourcedcfo.co.za or contact: info@outsourcedcfo.co.za.