Opinion holder entrepreneur Contributors are their own.
You may have heard that cash flow issues are the number one cause of business failure, but how serious is this pervasive problem? More than 20% of SMEs fail within a year and half within 5 years.
But it doesn’t have to be. In fact, many businesses can avoid cash flow problems with good cash flow forecasting. Cash flow forecasting helps businesses anticipate when problems may arise, allowing them to act proactively to avoid cash flow gaps.
However, many companies are already operating at maximum bandwidth and cash flow projections are not on the minds of management. Usually by the time a business owner hits a financial setback and realizes they don’t have enough cash to cover it, it’s already too late.
Many business owners don’t realize that the range of benefits they can derive from good cash flow forecasting goes beyond helping them run their business plans. If you’re still wondering why you should care about it, here are a few reasons why you should do a cash flow forecast.
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1. Helps businesses avoid cash flow gaps
This is the simplest and most important reason why cash flow forecasting is important.
Here’s the scenario: John’s client promised that the payment would be received by today, but there was a mix-up and the bank said he wouldn’t receive the money until next week. John is due to pay the vendor tomorrow, but he hasn’t received payment from the client and doesn’t have enough money to pay. The cycle continues.
This is why many businesses fail.
Cash flow forecasting helps companies avoid exactly this situation. Forecasts can be used to forecast the best-case scenario, the worst-case scenario, and everything in between. And you can use it to make careful decisions about how much money to spend, where to put it, and when to spend it.
Businesses may decide to postpone large purchases if they think the cash may not come in. Alternatively, you can talk to your vendor and get an extension of your accounts payable. Alternatively, you can offer your customers a discount for paying their bills early. Forecasting provides the knowledge companies need to take action and avoid difficult cash flow situations.
Related: 4 Tips for Managing Cash Flow in a Seasonal Business
2. Helps secure loans
Loans are an important part of running any business. Funding can help you expand your business, improve your products and workflows, or cover operating costs in an emergency.
However, financing is easier said than done, especially for businesses with few assets or no credit history. In this case, lenders focus on profitability, expenses and cash flow.
Strong cash flow projections help businesses prove their creditworthiness to lenders. Businesses can use cash flow forecasts to demonstrate loan eligibility and high credit risk. Or, if your cash flow projections aren’t, it may be a good time to do an internal assessment to improve your cash flow position before asking a lender for a loan.
3. Help companies make better decisions
Cash flow forecasts give your business a glimpse into the future. See cash in and out so you can plan for the future and make strategic decisions that fit your budget.
Let’s say a company is looking to hire additional staff or purchase new equipment. The business may look at how much money he has now, thinking he can cover the extra expenses, but what if he loses a big customer a week from now? Or what if sales plummet due to competition?
These are the kinds of things that account balances don’t tell you about, and are the exact reasons why businesses need cash flow projections. By understanding the future availability of cash, businesses can make informed decisions about when and how to invest for growth.
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4. Help companies set measurable goals
By leveraging cash flow forecasting, businesses can set measurable goals to tangibly improve cash flow and determine a path to better business outcomes.
You’ve got a benchmark number when your best-case scenario projections show that you could increase your business’ revenue by 50% by purchasing new equipment and improving operations.
Or, if you plan to reduce your expenses by 20% by reducing some of your business operations, cash flow projections will help you see the impact of project reductions on your business and bottom line, and how your financial cost savings will affect your business. It helps us to see if we are in line with our decisions. You can now set data-driven business goals, understand expected outcomes, and measure success.
These are two very different examples, but cash flow projections can help companies set measurable goals no matter what the business situation is.
Business forecasting is easier than you think
Regarding cash flow projections: This is nothing new, but it used to be a difficult, labor-intensive and time-consuming job that business owners left to their accountants. Fortunately, technological innovation has made cash flow forecasting easier than ever before. The new tool now integrates directly with many of the cloud accounting platforms used by businesses to make cash flow forecasts faster, more accurate, and in some cases free. Start looking for a solution that works with your accounting platform today and see the incredible impact it can have on your business.