Why businessowners need cashflow projections

No matter what type of business you run (retail, hospitality, commercial rental, professional services, or product manufacturing), it is important to manage your cashflow. 

Many businessowners focus on the profit made for the last financial year and use this as an indicator of whether or not their business is succeeding. However, profit is only one part of the successful business equation. 

Cashflow is an equally important indicator of how the business is doing – its financial stability, ability to meet its financial obligations (i.e. pay its bills), and potential for future growth. It is for this reason that lenders will look very closely at a business’s cashflow when considering an application for finance.

Profit does not equal cashflow
A mistake we’ve seen some businessowners make is to think that the profit their business is making should equal the money in the bank account. However, this is frequently not the case. If you use cashflow during the year to purchase business assets, for example, you could be showing a profit but have very little sitting in your bank account. Or you could have made a sale (which shows a profit), but you have not received the money for that sale yet. 

A business may be growing well and making a profit, but if the cashflow is not managed properly it can sound a death knell. Why? If you don’t have cashflow at critical times, you can’t pay your expenses, and this is what can cause a seemingly profitable business to fail.  

Managing cashflow

In a nutshell, good cashflow management is about keeping cash in your bank account for as long as possible. So, you want your customers to pay you as soon as possible, but you want to delay paying your creditors for as long as possible.  In other words, the shorter the time between when you pay for your goods and when you customer pays you, the healthier your cashflow will be. 

To manage cashflow effectively, you will need to prepare cashflow projections. Cashflow projections assist with many aspects of a business’s operations, such as long-term financial planning for succession, borrowing extra funds from the bank to grow or run the business, or making informed management decisions around things like hiring more employees, purchasing another business, or even selling a business or shares in the business. 

Cashflow projections are also essential for ensuring you have the money available to pay your expenses. For example, you need to plan so you have the cash to pay your tax on time. This takes a bit of forward thinking because many businesses have to pay tax when they invoice for a sale, not after the money from that sale is actually received. And of course you’ll need to ensure you have the cashflow available for other expenses as they come due, such as lease of premises, purchase of products, staff salaries, interest on loans etc. 

For some businessowners, the preparation of cashflow projections can be stimulating, but it can also cause some people’s eyes to glaze over. Whether you love them or hate them, they not only need to be prepared correctly but you also need to understand them in order to make the best decisions possible. 

What are cashflow projections?

Cashflow projections outline a business’s income and expenses for a particular period of time, e.g. 12 months, the next quarter, or even for the next five years. 

The assumptions being made during this process have a significant effect on the outcome – incorrect assumptions lead to incorrect projections. To be useful, projections should be prepared based on historical data, current data and even future data, which could have various starting balances. 

To have useable data, you will need to implement good reporting on such things as revenue, price of product or service, margin, accounts receivable days, accounts payable days, overheads etc. For instance, how long does it take for your customers to pay you? How long does it take you to pay your suppliers? How long does it take you to sell your products? You may need to take seasonal fluctuations into account. (There is a lot more to reporting that the short list provided here – but that will have to be another blog.)

Accurate data allows you to create reliable projections, meaning you’ll be able to make prudent decisions around funding and investment, while at the same time being able to manage short- and long-term liabilities more effectively. 

Reliable cashflow projections are not just necessary for internal business decisions. They are also essential if you are seeking finance, because your lender will require them before deciding whether or not to grant you a loan. This is the main reason our clients at GRA ask us to prepare cashflow projections for them. 

If you would like help with preparing a comprehensive cashflow projection for banking requirements or management purposes, please get in touch with GRA – we would be very happy to assist you with this.