At a time when the UK’s economic climate sees many small businesses struggling at the mercy of their lenders, there are three words that must be remembered: Cash is king.
Regardless of size or profits, a business will begin to struggle if it runs out of cash. While a business may survive without cash for a short period of time, if staff or suppliers cannot be paid, then products and services cannot be sold, and this cycle will quickly run a business into the ground.
For this reason, and particularly while trying to survive the credit crunch, it is vital for any business that cash flow is carefully monitored.
What is cash flow?
‘Cash flow’ refers to the cash that flows both in to a business (through sales), and out of a business (through expenses) each week.
Cash balances include notes & coins, current accounts and short term deposits, unused bank overdrafts and short-term loans, and foreign currency and deposits. However, long term deposits, long-term borrowing, money owed by customers, and stock are not included as cash balances
Cash flow should not be confused with profit – which is the balance between a business’s yearly costs and its earnings. This is because while a business may have a good yearly profit overall, there may still be times when the business is strapped for cash.
Why is cash so important?
Cash is the most important element in keeping a business afloat, as it will determine a businesses ability to keep suppliers, staff, and clients happy – all of which are essential for smooth business operation.
Most businesses will need to have their goods or services ready to offer clients before they can be sold; meaning suppliers or staff will need to be paid regardless of whether any sales have been made. If a business has run out of cash and cannot pay its suppliers or staff, then the business will have no products or services to offer. They will then be unable to generate any new cash flow, and the business will quickly deteriorate.
A healthy business should generally have at least as much money coming in to the bank as it does going out, but it’s the timing of this that is vital to smooth cash flow. There must always be enough cash in the bank to pay for expenses, so the movement of cash must be carefully monitored.
Why make a cash flow forecast?
Making a cash flow forecast is a vital part of cash flow management, as it will help to demonstrate the way in which cash moves within a business. Cash flow forecasts help businesses to predict whether the anticipated sales and income will be enough to cover the overall expenses of operation, and to analyse whether a particular project or venture is viable.
Even businesses that are doing well should make cash flow forecasts, as they can be vulnerable to something called ‘overtrading’. This is where a business may accept a large account from a client, but will not have the spare cash to pay suppliers in time. Because suppliers must be paid before the money from a client is received, the business can run out of cash and face severe difficulties.
The aim of a cash flow forecast is to help businesses avoid situations like this. Using the forecast, businesses may run various scenarios - such as the one above, a drop in revenue, or loss of customers. The forecast will then illustrate how well a business would cope in situations like these. Essentially, the purpose of a forecast is to spot potential problems before they arise.
How to make a cash flow forecast
A cash flow forecast will list the amount and sources of cash coming in, as well as the amount and destinations of cash going out of a business, and will list the predicted amounts alongside actual amounts as they become known. Forecasts will usually be made for between a quarter and 2 years in advance, and will be divided up into weekly or monthly periods depending on the frequency of your fixed-cost payments. The following factors will be listed in a forecast:
• payments
• receipts
• excess of receipts over payments - with negative figures shown in brackets
• opening bank balance
• closing bank balance
Generally, a cash flow forecast will be created on an excel spreadsheet, as this will allow the user to instantly see the impact that certain changes would have on a business. Businesslink.gov.uk provides a good cashflow projection worksheet, which gives an example table, as well as guidelines and explanations on creating your own forecast.
Businesslink also suggests the use of accountancy software to assist you with your forecast, as this will allow you to easily update your predictions should a sudden change in business finance or market trends occur. You can also use the software to make "what if" calculations, making it easier to plan for a number of scenarios. There are numerous accounting packages which may be used to make cashlfow forecasts, so for more information see businesslink’s guide to accounting software.
Using your cash flow forecast effectively
Your cash flow forecast will play an invaluable role in your businesses financial planning, so long as it is regularly updated with accurate information. This will mean frequent adjustments based on a number of influential factors – such as changes in staff costs, product demand, tax changes and interest rates.
With an accurate and up-to-date cash flow forecast, you should be able to make practical predictions regarding your business finance. With the ability to spot potential problems before they arise, you can then take appropriate action to stop them from materializing.
Not only will a cash flow forecast allow you to identify any major holes in your finances, but it will help you to decide whether a particular financial commitment is viable – whether it be a development of the business, or taking on a large account from a client.
Having a carefully monitored cash flow system will assist any business in achieving steady growth, as it will help to ensure that suppliers, staff, and customers are kept happy. Cash flow forecasting will be vital for many businesses struggling in today’s economic climate, but even those businesses doing well should take heed. There’s nothing to say that a business won’t one day receive a very large spanner in the works, and being prepared could make all the difference.
Related links: www.businesslink.gov.uk
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