Forecasting cash flow is an important part of growing your small business, but it isn’t always easy.
Depending on the type of product or service you offer, and the kinds of borrowing needs you may have, it’s easy to fall into a negative cash flow situation. We often see business owners struggling with cash flow management, and in a small business, this can make or break your long-term success.
There are different ways that cash flow tracking and forecasting can go awry, but today we’ll focus on the biggest mistake that small businesses make when trying to forecast their cash flow. First, though, let’s look at why cash flow can become such a challenge.
Why Tracking Cash Flow is Complicated
Tracking cash flow can be a very complicated process — sometimes deceivingly so. To track it accurately, you have to look at each business expenditure based on when you’re actually going to pay it (as opposed to when you receive it). Depending on the different types of expenses you incur, there are likely different payment schedules for each. Consider payroll, for example. Those expenses are probably paid out to employees on a weekly or bimonthly basis, but payroll taxes are paid quarterly. Insurance costs, on the other hand, are typically paid annually or biannually. As you start to break down every expense line in your financials and try to anticipate when you’re going to have to pay each one, the process can become very lengthy and very complex – and as a business owner, you likely don’t have the time, or perhaps the expertise.
For this reason, it doesn’t make sense to manage this process without some kind of automation. We recommend software that can download actuals from QuickBooks Online, and we recommend looking at when you paid for each expense to help you forecast those same expenses into the future. This becomes even more helpful in cases where you have to make assumptions about future expenses. Maybe you know that your insurance costs are going to go up for the following year, so you know you’ll need to make an adjustment to your cash flow forecast. Being able to input this information into a system that helps you with forecasting means that you’ll know sooner about any potential cash flow shortage and have time to plan for it.
The Biggest Mistake Small Businesses Make When Forecasting Cash Flow
As mentioned earlier, there is one major mistake we see more small businesses making when it comes to forecasting cash flow. That mistake is over-anticipating when revenues are going to come in and under-anticipating when expenses will go out. Virtually any business owner will look at their financials and want to think that they’re in a sound financial situation. They’ll want to believe that every customer is going to pay on time 100% of the time, because that’s always what they hope will happen.
Unfortunately, that’s almost never the reality. As accountants, we see very few of our clients’ customers paying on-time 100% of the time, even in a strong market. As consultants, what we do when working with a client on cash flow forecasting is we look at their specific industry and make assumptions accordingly about how many clients are going to pay late, and how many clients are not going to pay at all. By making these kinds of assumptions based on industry data, we can make more accurate forecasts that help our clients identify when or if they’re going to have a cash flow shortage.
Another benefit of having accurate cash flow forecasting is that you’ll gain insight into the future financial state of your business, including the likelihood that you may never come out of a cash flow shortage (which means you’re then operating at a loss). With this information, you can either take steps to reduce your expenses or increase what you’re charging for your product so that your business will be profitable and eventually your cash flow shortage will become cash flow positive.
Forecasting in Action
Let’s look at a real client example of an optimal cash flow scenario, one where we helped the client to realize many business successes through accurate cash flow tracking and forecasting. We had a landscaping client who was hoping to grow their business. They hired us to help them with cash flow forecasting, and with the data we collected, we helped them to grow their business across the board. Not only did they purchase additional equipment to increase their business capacity, but they hired new staff because, according to the data, they knew they had the cash available to do so. The forecast we provided also gave them an accurate picture of how many months they’d be able to work without having to worry about a negative cash flow. Through our work, they were better able to plan for their business needs and succeeded at overall growth. Without knowing how long they were going to be cash flow positive they probably wouldn’t have made the leap into buying more equipment and hiring more employees, thus becoming more profitable overall.
Most small business owners are emotionally invested in their businesses. These ventures certainly take a lot of work and dedication, and of course as an owner you want to see your business succeed. As consultants and accountants, we’re able to offer our clients a realistic and objective perspective based on the financial health of their business. We know that, of course, you want to sell 100% of your product, but thinking realistically, maybe we base your pricing on you selling 85% of your product instead. What is sometimes hard for an intimately attached business owner to see is where we, as outside consultants, excel. We help businesses make the kinds of decisions they need, not only to be cash flow positive, but to reach their overall business goals.
The Takeaway
Accurate, realistic cash flow forecasting is critical to the continued growth and success for any small business. Sometimes the best way to achieve that is through partnering with a small business advisor who focuses on growth and profitability, and who can help guide you through the sometimes-murky waters of cash flow management – and let you get back to business.