Dear Will

Last month in Forecast I discussed the full set of management accounts that you can use to manage your business. Click here if you missed the June issue and would like to read it. This month, I’m focusing specifically on cashflow statements and short- and long-term cashflow forecasts.

Please feel free to forward this issue to anyone else you think will enjoy reading it and find it useful. If you’ve been forwarded this issue of Forecast and would like to receive your own free bi-monthly copy, you can subscribe by clicking here.

With best wishes,

Graham

Why Do You Need a Cashflow Statement?

What sometimes comes as a nasty shock to enthusiastic new business owners is that when you send an invoice out, it doesn’t mean you get your money straight away. Whatever terms you impose on your customers, there can still sometimes be quite a gap before they get round to raising payment for your services. It’s vital to come to grips with the concept of cashflow and use your cashflow forecasts to keep your business in healthy shape.

Your cashflow statement shows your business’s income and  outgoings, and leaves out all other items which may appear in your profit and loss account, but not affect your bank balance (such as depreciation). It’s a statement, a historic statement of fact. As a small business manager the cashflow forecast is probably of more significance to you. Many business owners make the mistake of focusing only on profit, but the timing of payments into and out of your business is as important for business success as profit. This is your cashflow.

It’s crucial to make sure your cashflow is sufficient for your regular outgoings, such as wages, VAT and tax bills. Your profit and order book might look healthy on paper, but if you can’t convert it to the cash you need, your cashflow is negative (you need to buy the stock before you sell it!). If in reality it will take some time to get the money in, and you are unable to pay your bills, you are in trouble (We’ll talk about ways of dealing with this in the October issue of Forecast, which will look at credit control). This is called ‘overtrading’, and can lead to the failure of your business.

To avoid this, I recommend the use of a combination of tools, the working cashflow, for short-term cash management, and a long-term forecast for budgeting purposes.

How Do You Create a Working Cashflow?

Whatever system you are using, whether it’s a spreadsheet or an accounts package, it’s quite simple.

Enter  all the invoices you have raised. Put an estimated figure in for income for 30 days (or  your best estimate of how long it takes for you to be paid). Do the same for all your known or predictable outgoings over the same period. Then subtract one from the other.

The final total is your net cashflow and you should update and reconcile this weekly with what’s in your bank account – it shows how much ‘should’ be in your bank account at the end of the next week. It’s very important to monitor your cash flow regularly to keep track of what you owe and what is owed to you – don’t leave it and hope to catch up later. It can help you plan what invoices to pay and in what order (though don’t include your VAT or tax bill in this tactic!), and this can sometimes make the crucial difference between a healthy and an unhealthy cashflow when things are tight.

The Long-Term Cashflow Forecast

This involves making an estimate of your revenue each month. This is then balanced against a prediction of your outgoings over the same period, and allows you to budget for large irregular payments, say for stock, new premises, capital items, tax etc. This forecast is used to show your bank and your other investors that you have made careful provision for the medium- to longer-term. It’s a good idea to set up a process for doing this on a regular basis (at least annually).

As a business owner, you should always compare your actual with your predicted cashflow. This comparison will show if things have worked out as you expected. If they have not, then you should examine closely the reasons for the difference. This will help you plan more effectively for the future, and may help prevent a cash shortage. You can only do this comparison if you have both sets of figures, actual and predicted. The closer these two documents are in financial terms, the more understanding and control you have over your business.