Cash flow planning is a critical function for all businesses, but especially small businesses. If a large company with a hefty bank account has an unexpected expense or a slow month of sales, they are more likely to have enough cash on hand to cover it or a bank credit line they can tap.
Small businesses often don’t have access to the same resources so managing cash flow and even setting aside reserve funds if possible is crucial.
Some other reasons cash flow planning is so important are:
Decision Making
Planning can help a business decide how to reinvest profits. They may need to purchase a new vehicle or equipment, expand operations or build up a reserve fund.
Monthly Expense Management
Does your business have enough cash to cover one month of expenses? The first step is to identify all monthly costs like rent, payroll, insurance and debt payments. That will tell you how much cash you need to continue operating each month. It is strongly recommended that businesses set aside at least one month of expenses into a reserve or savings account. That will leave you prepared for unexpected hiccups along the way.
Cyclical Sales
Are your sales spread evenly and consistently throughout the year? If not, you are in good company! Many businesses have somewhat of a cyclical pattern. For some, businesses slows down in the summer and around school holidays when people are on vacation, for others holidays and vacations are their busiest times. Regardless of where your business fits into that, simply understanding the cycle will help with cash flow planning, and ensure that cash is set aside from the busiest times to cover expenses during slower times.
Growth
If you are considering growing your business by opening a new location or adding a new product or service line, effective cash planning can you help determine if you can afford it. Although the purpose of growth is to generate more revenue, if you are taking on debt then the future principal and interest payments are an important consideration. Will there be enough additional cash to cover the payments?
Cash Flow Methods
Direct
The most straightforward way to approach cash planning is by analyzing historical monthly cash-in and cash-out to get a clear picture of the cash flow over time. This helps determine cash needs and expected cash inflows. This can be done for various periods of time, but monthly is a good general approach.
Forecasts
This takes the direct method one step further, and estimates how much cash will be flowing in and out in the future. This is generally extended beyond the current year.
Projections
This is similar to forecasting, and incorporates historical trends into the current year projection. It also incorporates expense budgets, sales forecasts, and any known assumptions.
Scenario planning
Involves creating multiple forecasts, generally best case, worst case and most likely. This helps businesses plan for unexpected changes – good or bad. A best case scenario might be expanding services which you think will take 3 years to become profitable, but instead it only takes 6 months. Planning for that best case scenario ahead of time allows you to shift to that plan, which you have already prepared. Similarly, the worst case plan helps you in the other direction. What if the expanding service turns out to not be viable, after you’ve sunk a bunch of money into it? While it’s not an ideal result, you already have a plan in place that you can shift to and most importantly, because of your cash flow planning you knew your business could survive it.
Cash Flow Tools
Accounting Software like QuickBooks have some basic cash flow management reports. They are a great place to start if you are looking to incorporate cash flow planning into your business.
Dashboards
Visuals built into a dashboard are another great way to manage your cash flow. They can help you analyze your performance vs the budget, monitor your projections and forecasts. You’ll be able to make decisions based on the results that you are seeing and monitoring.
Spreadsheet
I love technology tools as much as anyone, but often times using a spreadsheet is the best way to get started. They are relatively easy to get started with and import data into. The first step is often the hardest, so simply getting started is the most important step no matter which tool you choose.