Accurate Cashflow Forecast

Last month I met with three clients to discuss, among other things, their cashflow – or at least for one of them . . . the lack thereof.

As a business consultant, to meet with a client and NOT ask about their Cashflow would be like you visiting your doctor and NOT being asked how you are feeling!

Cashflow is the lifeblood of any business. A savvy business owner is well advised to get a firm grasp on the concepts and best practices of Cashflow Forecasting.

In this article I will introduce you to our 3-part process for developing an effective and accurate Cashflow Forecast. It involves Activities Planning, Collections Forecasting and finally, Cash Management.

Just to be clear, what I’m referring to in this article is the cash coming into your business, AND the cash going OUT.

When many people first hear about Cashflow Forecasting, their mind immediately races to forecasting sales and collections – which is only a part of the equation – and a small part at that!

As you will soon learn, there are many facets to a properly designed Cashflow Forecast and surprisingly the most important one does not deal with dollars or cents. It deals with the businesses activities that are in some way related to the dollars and cents. We call this the Activities Plan.

Activities Planning

As a business consultant, I’m astonished that so few of my colleagues give consideration to activities planning when teaching about Cashflows. It seems counter intuitive to me.

The main idea in activities planning is for you sit down and list all non-sales related activities first. If you are an existing business, it might help to have your day-planner in front of you, and review your daily activities over the past 12 months.

If you are a new business, it will help to speak with colleagues in similar but non-competing businesses, or a Mentor if you have one. Whatever the case, having a clear understanding of all the “hats” you wear will give you a better idea of the time commitments related to wearing those hats.

Let’s face it . . . the time devoted to essential activities that are not directly related to sales, is sure to place limits on your selling activities. This translates to a limit in your actual sales. Many Entrepreneurs overlook this and then they wonder why they can’t meet their sales targets.

After identifying all non-sales related activities, you will then examine all selling-related activities that take place over the same 12-month period. What is sure to develop is a very clear picture of your businesses operation over a full year. This clarity will help you research and forecast the costs and revenues associated with each of these activities. Get the picture?

To be clear, every business will have a unique activities plan that is specific to their industry, driven in part by the philosophy of the owner and the habits of their target client. No two businesses are likely to have the same activities plan.

After you have identified YOUR seasonal activities, forecast those of your customers. Understanding the seasonal characteristics and habits of your customers will lead to a more accurate forecast of their purchasing and payment habits. For instance, bad debt is more likely in the three months following Christmas than it is in the three months before Christmas! Being aware of this will help you develop sound payment and collection policies that will make your cashflow forecast more accurate.

Collections Forecasting

As you have seen, it will be much easier to forecast collections from your clients if you have a better understanding of their habits. The concept of activities planning is well aligned with this.

Where possible, and if your industry supports, try to collect from your customers AHEAD of time (called a “prepayment.”) More importantly, collect from your clients as soon as the services are rendered.

Nick was one of our clients who was a custom cabinet maker. He quoted a large custom kitchen for a new client, Jenny, in the amount of $22,000. The agreement with Jenny was a payment of 50% upon the acceptance of the quote, the balance of which would be due on delivery of the cabinetry.

On the day of delivery, Nick carried the first cabinet up to the front door of his clients house and rang the bell. Jenny cheerily greeted him.

Nick politely handed her the invoice that showed the balance due, and Jenny quickly told him that she was unable to make it to the bank on the way home from work. She offered to get him a certified check on Monday, which in this instance happened to be a holiday when the banks were closed.

Nick reminded her of the holiday Monday, and then quietly picked up his cabinet and brought it back to his truck.

Jenny was visibly upset, but Nick stood his ground. He politely reminded her that they had an agreement, the terms of which she was unilaterally changing. He advised her that he would complete the delivery and installation of her new kitchen only if she was able to meet the original terms of their contract.

In actual fact, it took Jenny 3 more weeks to come up with the balance of the account!!

What would you have done?

In my experience, a customer living through cashflow difficulties who is up-front with me is not nearly as much of a credit risk as Jenny.

In reality, if Nick had delivered and installed the cabinetry, his options for collection after-the-fact would have been costly and unpredictable. It’s the business dealings of this sort that lead to cashflow difficulties.

Having a good understanding of your client will help avoid these situations. It’s also a sound business practice to make sure your clients stick to YOUR collection policies. It’s never a good idea to allow your clients to use you as a bank, and it’s certainly not acceptable for them to force you into this corner!

For any business that does not extend credit, forecasting collections is pretty easy as the collections will be equal to the sales that were forecast during that period.

Some businesses however, may be forced into extending credit if that’s the common practice in their industry.

Now to be sure, I’m not saying that your business MUST march to the beat of your industry’s drum. If you prefer not to extend credit even though your competitors do . . . then don’t!

Give your clients a reason to pay up front and they will. Benefits such as lower prices, a great business location, or superior customer service are excellent reasons to attract customers without extending credit. 

If you do extend credit, then I highly advise you to be in the driver’s seat. Managing credit can and should be secondary to managing your client’s expectations if you do it properly.

Make your customer clearly aware of your credit policies upfront, and your collections will rarely be a problem. Loose to non-existent credit policies however, undoubtedly lead to overdue accounts and unpredictable cashflows . . . and that’s a problem!

Credit policies do not have to be complicated or wordy. I choose “clear and concise” over the complicated “legalese” any day. One liners such as “Due on receipt,” or “Net 30” are more than sufficient, but they are made more effective when followed by a politely worded email or phone call the very day they become past due.

A building supplier I deal with is efficient at sending out PAST DUE notices the day after an account becomes past due. They don’t wait until the end of the month, or two weeks . . . or even 2 days . . . they prepare the notices at 4pm on the due date so their clients are duly notified in the instant the account is past due. They then follow with a telephone call in 48 hours.

Guess what? They *never* have bad debt.

When I tell this story in the classroom, I often see 2 or 3 people wince. For some reason, they think this practice is too harsh. I think it’s important to remember, that being loose with your collection policy is not considered good customer service, so don’t confuse the two. In fact, the two are not even related.

It could be argued that strictly enforcing collection policies (albeit in a nice way) keeps clients in your good graces. As this is in their best interests, it could be considered good customer service.

Collecting money can be a tough thing. In the early 90’s I was hired by a Pub to get their books in order. They had come under hard times and were planning an orderly wind-down.

As their bookkeeper, I knew better than anyone just how strapped they were for cash. I remember feeling terrible every time I issued them an invoice because I knew better than anyone about their inability to pay.

Sure, over the course of 6 months I did get some money, but when they finally closed their doors they owed me over $1,500.

I ended up with half a bottle of scotch, a bar sign and a well-used dart board - which I still have incidentally . . . except for the scotch ;)

In the years since, I have become much better at collecting money but the one best-practice that I can share with you on this topic is . . never give your clients a long rope to run with. Be like my building supplier and stay on top of your customers (again . . . I stress . . . in a NICE way). Be the first to extend your open palm of collections and you will be the first to be paid. If this makes you uncomfortable, then have a colleague or business associate play the role of Collector for you.

Even though I’m much better at collecting money now than I was in the early days, I still have the odd client who makes me uncomfortable. I have the perfect colleague who so willingly and politely acts as my Collector and I am happy to reciprocate for her.

Cash Management

This is the part where we “crunch the numbers.”

For the “non-numbers” types, I have an important piece of advice that will help get you through this.

“Deal with the numbers that you already know, or are the easiest to determine. Worry about the unknown numbers later.”

Most cashflow forecast templates have up to 30 categories of numbers to fill in, however on average, most businesses only use 11. Don’t be overwhelmed by the template. It will be much easier to deal with the unknown numbers on a worksheet that is partially complete than if the sheet is empty! :)

Once you know your sales and collections forecast, plot these figures on the cashflow spreadsheet. I recommend all of my clients to plot the cash outflows first as they are usually the ones that are most predictable and the easiest to identify. Outflows such as rent and bank charges are static and are readily determined. Deal with those first and get them out of the way. You will be rewarded by the fact that there are now two less categories on the spreadsheet to deal with.

After the worksheet has been completed, determine the overall cash surplus or shortfall. How does your business model support this? Will you have to borrow money to balance the books? Do you have personal cash resources to cover a shortfall? If not, then you are well advised to make changes to your operation, or if in the case of a new business, consider not going ahead with it.

I can appreciate the latter decision is usually the hardest to make.  

When I was taking my flight test for my Pilot’s license, the weather that day in February was marginal at best. It was -24F (no kidding) with snow squalls looming over northern Lake Ontario. . . . yet . . . it was still sunny to the north.

Part of the test was for me to complete a one-hour cross-country flight plan. I successfully reviewed my pre-planning documents with the Examiner after which we headed outside to the aircraft.

Shortly after we became airborne the snow squalls blew inland off the lake.

The visibility was quickly deteriorating.

I was totally torn. I *really* wanted to complete the test but was afraid if I made the decision to not do the cross-country flight, I would fail.

After about 20 seconds, and while we were still within sight of the airport I told the examiner that I was not comfortable in completing the cross-country flight and that I was pulling the plug.

He told me that if I had let one more second slip by before making the “no-go” decision, he was going to fail me.

We then did a few airborne manoeuvers after which he passed me . . . with flying colours.

It actually never occurred to me in the moment, that the flight test could still be considered a success if I made the no-go decision.

Since then, I have recommended many clients make the “no-go” decision with their businesses when the cash-flows did not support. I’ve always considered each of those decisions to be the successful ones . . . because they were.

Summary

Cashflow Forecasting is actually not a difficult process although it can (and should be) time consuming the first time you do it. That being said, it IS a living document, and one that all successful Entrepreneurs update and manage on a regular and continuous basis.

The more you work with it, the better and more comfortable you will become with the process.