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Promoted by CashFlowMapper
Why your clients need to pay attention to cash flow forecasts - and how you can help them do it
01 June 2016
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7 minute read
There’s a reason financial advice comes with a disclaimer, something along the lines of “Past performance is not indicative of future results.”
It’s true that looking at trends in profit and loss can indicate future performance. However, historical information doesn’t include things yet to happen: new customers, new suppliers, new pricing and lower costs.
Last year’s or last quarter’s results don’t consider what’s still to come. Profit and loss statements don’t contain forward-looking information, which can only be found in a cash flow forecast.
Two simple reasons to focus on cash flow forecasts
1. Prepare for the unexpected - the bad and the good
The main reason many businesses focus on cash flow is to manage funds during a crisis.
But what about when times are good? When sales are up, and everything is humming along as it should be. Business owners or financial controllers can often overlook their cash position because it’s not screaming at them every time they check the bank balance.
Knowing when excess funds will be available to take advantage of is often ignored and can mean that extra cash is not put to good use.
Is it better to pay down debt or invest in assets or expansion? Will the excess funds cover all of these costs? Will these funds reduce the amount of financing needed for future activities?
Focusing on cash flow during the good times is just as important as during the bad times. The unexpected suddenly becomes the expected – and much easier to manage or take advantage of.
2. Operating cash flow is the KPI of an ongoing business
Operating cash flow is simply the net cash flow of the day-to-day operations of a business. That is, the cash you get from customers less the cash spent servicing them.
If net cash flow is positive and growing, excellent! If not, there are issues to address to rectify the situation before it gets out of control. Without positive operating cash flow, there is no operating business.
Consequences of being in control of cash flow & positive cash flow
1. It’s all about power and efficiency
Having more cash on hand means a business has increased purchasing power to buy what they need to operate. They may be able to take advantage of supplier discounts for paying on time and any discounts for volume purchases (assuming it makes sense to be buying these quantities).
And, if your client does need to take out finance, they’ll be in a better position to negotiate a more favourable interest rate or payment terms. Financiers will have more confidence in your client, and they will be seen as less of a risk, leading to cheaper finance and less pressure from equity holders.
2. Anticipate and absorb downturns
Businesses can more easily absorb downturns when they have cash on hand. And with the discipline to forecast cash flow, they can anticipate downturns and put in place actions to smooth out the consequences.
When business owners know a lull is coming, they can advise creditors in advance and negotiate terms and repayment plans. It puts them in a stronger position to negotiate and helps build reputation and credibility in the market.
3. Opportunity waits for no one
Businesses that have their own cash readily available can act quickly and decisively in terms of expansion, acquisitions, and asset purchases. Maybe a more prominent shopfront is suddenly available, or there’s an opportunity to acquire a competitor.
Whatever it is, chances are it won’t be available for long, so being in the position to purchase now can make all the difference. Even if additional funding is needed, it will generally be on more favourable terms and faster than a competitor not in as strong a cash flow position as your client.
4. The value of your business increases
Businesses can exist for many reasons, such as supporting the community or fulfilling another social or ideological purpose. But if they don’t generate and effectively manage cash, they die.
Valuations of businesses increase markedly for those that have both cash assets and continue to generate cash. Plus, it keeps debtors, creditors, and equity holders happy.
5. Your people are happier and more motivated
Ask any employee or contractor – the more secure they feel about who they work for or with, the happier they are. Positive cash flow usually means a solid business, resulting in ongoing work for everyone.
As a result, employees and contractors will be more motivated to do good work, collaborate with colleagues, and contribute good ideas… the list goes on. Also, businesses will be more likely to hang on to and attract good people. It’s the people who make your business, after all.
How advisors can help
1. Educate your clients on the benefits of looking ahead
It’s a case of the future versus the past. With the right information and forecasting tools, the latter informs the former and can help map different scenarios and forecast your cash position.
It’s the difference between setting out on a road trip with a GPS displaying real-time information and using an old fashioned street directory.
One tells you to detour when a road is temporarily closed, while the other has no idea.
2. Take on a leadership role
The Australian Securities and Investment Commission (ASIC) and Australian Small Business and Family Enterprise Ombudsman (ASBFEO) have cited inadequate cash flow as a leading cause of business insolvency. Insolvency can result from late-paying debtors or overpaying for goods and services.
Use these examples as a prompt to analyse your clients’ businesses, paying close attention to the cash flow implications of all aspects of the business. Debtors and creditors analysis is generally the most important, and most businesses do this. It’s the discipline around collections that is usually the biggest weakness. Don’t forget to look at how you can alter cash flows around investment and financing cash flows as well.
3. Cash flow planning to be BAU
Just like developing and reviewing a profit and loss statement and keeping an eye on the balance sheet, incorporating a cash flow budget should be part of any business’s annual planning and budgeting process. Ideally, assessing cash flow should form part of a periodic review process with your clients. This review should incorporate historical figures and forward-looking forecasts to be ready to take advantage of surpluses or better manage lulls.
Summary
The cash flow forecast is the most important business report. It’s more important than the profit and loss and the balance sheet. These latter two reports are important but can’t suggest what the future might hold – that’s the job of a cash flow forecast.
Too often, businesses focus on cash flow only when things get tight, and often it can be too late, and a business can be profitable and bankrupt simultaneously!
Cash flow forecasting is about being prepared as best as possible for unexpected shocks to the business, keeping you insulated from the negative and well placed to take advantage of the positive.
About CashFlowMapper
CashFlowMapper is a powerful online cash flow forecasting tool that makes it easy for anyone to understand their cash flow. Rolling forecasts, scenario mapping, business alerts, and easy to use (and understand) reporting help businesses and their advisors make informed decisions based on real-time data.
Our four-step guide to taking control of cash flow can help your clients better understand the importance of cash flow forecasting.
CashFlowMapper is a powerful online cash flow forecasting tool that makes it easy for anyone to understand their cash...
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