• Jonathan Augelli, CMA

Why You Should Forecast Cash Flows

Profits do not equal cash flow. This is one of the most surprising lessons entrepreneurs often learn. As an old instructor of mine once said, "I've known companies that were making profits hand over fist, but if it cost a dollar to go around the world, they couldn't get out of sight". Profit, as we all know, is revenue minus expenses. Cash flow, however, is tied to the timing of cash inflows and outflows. You earn revenue when you complete a sale, but you often do not receive the cash for that sale for days or even weeks. The length of time it takes to receive cash from a sale varies widely by industry.

Likewise, the outlay of cash to obtain or create your product or service, normally happens in advance the sale and in advance of the cash inflow. Again, how far in advance depends largely on your industry and business model. Layer on top of this dynamic the intricacies of when your various operating expenses must be paid, (ex. rent is monthly, but insurance and estimated taxes may be quarterly) and you can see how important it is to create a cash flow forecast. It is better to know months in advance you will be tight on cash a certain week than to discover it the week before. The earlier you become aware of a potential shortfall the sooner you can takes steps to mitigate or eliminate it, such as stepping up collection efforts, securing a line of credit with your bank, and reducing or delaying cash outlays. Significant shortfalls may require more drastic action, such as capital infusion via equity of debt financing, or scaling back on expenses or investment.

Keeping a close eye on your cash flows also gives you an advantage during crises like the COVID-19 shutdown, or a severe economic downturn. During a crisis, having a strong handle on your current cash position, and your cash needs over the next few months allows for better decision making. The ability to describe your exact cash needs will instill confidence in your lending institution that you will weather the crisis and be able to repay them. It also may allow you to effectively ask vendor for payment extensions if they know it is temporary and you describe a plan for repayment.

A cash flow forecast is an essential component of an effective financial management tool kit. Cash budgets should be prepared during the annual budgeting process and reviewed and updated monthly or quarterly. Growing your business without careful cash management can create cash flow shortages, and in severe cases, bankrupt your company. Conversely, intelligent management of cash gives you an edge for daily operations, handling crises, and growing your business to new heights.

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