Would businesses fail if they had an accurate cash flow forecast and they knew how to identify cash flow problems?
Knowing the nature and extent of your cash flow problems is key to being able to solve the issues that are causing it, solving short term problems, and avoiding the next one. Most businesses have some idea about cash flow but fail in the details.
An example of cash management failure
We once worked with a company whose previous bookkeeper could not deliver proper job costing reports. When Entreflow took over the file, we dug into the numbers and found issues with their labour jobs. It turns out that they never estimated labour anywhere close to reality and even though they had a contingency in place to go back to the customer for more budget if the job took longer than expected, they never exercised this. They were essentially paying for the labour for their clients — what kind people! Because of this, cash was always tight. They needed a new pricing strategy, but they also needed a cashflow forecast to ensure that they could finish off the year solidly.
Forbes lists cash as the 2nd most commonly reported reason for start-up business failure even amongst funded ventures.
Why you should plan your cash flow
For businesses that have high upfront costs before they can earn revenue, cash flow planning is a must. It can be done for any period of time. However, for most startups and growing companies, it’s most useful to use monthly predictions. If it’s built correctly, there will be no significant surprises, you’ll know reliably how much runway you have, and you’ll have a model you can use to conduct what-if analysis on business decisions.
The first step to cash flow planning is that you’ll need to collect some data. You’ll need to know when all of your bills need to be paid, what pre-authorized debits you have, so you know when money is going out of your account. Payroll is often the largest cash expense so make sure to forecast it properly — many businesses forget to include 3-payroll months, bonuses, benefits, hiring expenses, vacation pay, payroll tax. Also make sure to look for annual or quarterly bills. If you have a cloud-based accounting software like Quickbooks Online or Xero, you should be able to get these data quite easily.
Next, you’ll also need to separate out what are fixed costs, and what are variable costs. Fixed expenses are committed; variable costs go up as sales volume and related activity increases. A Fractional CFO can help with your cash forecasting and cash management.