When you started your business I’m sure your advisor, whether that be your bank advisor, financial advisor, or just your experienced friend who you turned to, advised you that you’d need to work on a cash flow forecast pretty soon so you’ve got a clear idea of when your going to have to pay different bills but also when you’re going to get money coming in so that you can pay these bills.
It’s a must-do activity for every business, from small to big, and invaluable in helping you keep your business afloat. I’m sure you’ve heard the statistics of the number of new businesses that fail within the first couple of years and that the major cause of this is the lack of flowing cash rather than a bad business idea or a failure to get enough customers.
So why is it that so many businesses fail even though they’re all advised to set up a cash flow forecast?
The answer is that the cash flow forecast isn’t accurate enough to actually manage your business by. This could be for a number of reasons.
Firstly it might not be kept up to date as regularly as it should be and so it becomes more of a reporting document rather than a management document. It should be updated whenever there are changes to the elements contained within it. If you get a new bit of business then the income should be reflected in it, or if you identify a new expenditure that will occur in a month’s time then this should go in once you know about it.
Without it being up to date you won’t be in a position to make informed decision elsewhere in the business. How can you decide whether to buy a new computer to replace the slow one you’re working on now? How can you decide whether you should invest time to chase that new customer who is located a little further away than you’re used to?
The second reason it won’t be accurate is that chances even if it is kept up to date that you’re being overly optimistic about when things will happen, whether that be when you’ll sign the new deal or when your customers will pay you.
It is this last factor that many people overlook, because they assume that their customers will all pay them within the payment terms that they’ve agreed to, when in reality, many companies don’t do this at all. This can make a real difference.
If you’re expecting to be paid in 30 days but you don’t get the money for 50 days, that pushes out your cash-flow quite considerably and means that you won’t have the money when you expected it and thus you can’t pay your bills when you expect to. So the best thing to do is adjust your cash-flow to when you’ll actually get paid, not when you should get paid.
To do this you either learn from previous experience which customers will pay you when (for example, you know that ACME Ltd always pay you at the end of the month after invoicing, regardless of when they get the invoice then you should adjust to reflect this), or alternatively you get some insight into the payment behaviour of your clients from their credit reports. These reports contain values such as a company’s Payment Beyond Terms, which is a value given to indicate on average how long after an invoices due date the company pays. This is calculated based upon a company’s payment history across lots of other organisations with whom they do business so can be quite valuable for you to know.
So take steps to face reality, and do it regularly, if you want your cash flow forecast to be a useful tool to support you make decisions in your business.