Cash flow forecasts - Making cashflow work in your business

Importance of Cash Flow

More businesses fail for lack of cash flow than for want of profit - " Profit does not equal Cash". So unless you collect the money from your customers on a timely basis and whilst your business might show great profits it will run into serious cashflow difficulties.

Companies need to plan both the short-term and long-term funding requirements of a business. This is where cash flow forecasts are an essential tool and help business owners to project likely cash requirements and to project profitability. Profit is vital indicator of the performance of a business and is the difference between sales and costs within a specified period. However, the generation of a profit does not necessarily guarantee the development, or even the survival of a business.

Overtrading is where companies have a high turnover and yet they are not collecting the cash quickly enough to pay their suppliers. The problem of overtrading can sometimes be easily solved by changing the payment terms of customers versus the suppliers. To have a successful business and good cash flow you need to have supplier terms that are at least equal to or better than those given to your customers.

Another way around this problem is to Factor your invoices also known as Invoice Discounting or Invoice Financing. Factoring is whereby the company is advanced cash from the factoring company immediately after the invoices has been raised. The advance can only be on 'Business' customers so invoices to individuals are excluded. A normal advance is around 80-85% of the invoice value. Of course Factoring costs and there are usually two charges levied by the factoring company: firstly there is percentage of turnover of somewhere between 1-2% charged; secondly, interest is charged on the cash advances.

Cash Flow verus Profit

Sales do not directly equate to cash inflows to a business as costs do not necessarily coincide with their associated cash outflows. This can be illustrated by way of the following tables:

The above tables demonstrate that although a business is profitable it needed at least £17,500 of loan or overdraft facility to fund the supplier purchases until the bulk of the sales had been received in month 3. If we add another month and if sales doubled you will see how, although the business is doing very well, by month 2 the business requires cash finance of just under £50,000.

In the table below we have given an example of the cash flows if the business were to factor its sales invoices - as you will see the ending bank balance is very much different. However, in this case the financing which might have been originally by way of an overdraft, has been replaced by factoring finance. For this example it is assumed that the factoring company is advancing 80% of the amounts invoiced.

By using a factoring company the business in the example no longer requires and overdraft facility and instead of having a negative cumulative net cash flow of £47,500, instead it has a positive balance of £82,500!

The above example is not the whole picture, as most businesses have other costs associated with running the business which include staff salaries and premises expenses like rent and rates (or property taxes). If these had been taken into account then the net cumulative cash flow position would have been a lot worse. Also, if this was a start-up business scenario then you might have to take into account capital expenditure on new equipment etc.

What we are referring to here is 'Working Capital' and the 'Cash Cycle' and a cash flow forecast can help business owners plan for the maximum facility needed. It also allows for working out what terms might be needed between your business and its' customers and suppliers. It is essential to forecast cash flows as well as project likely profits and how the inflows of cash impact on the outflows of cash.

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