The latest addition to our digital video series BCGH in Conversation features Chris Backhouse from Enterprise FD. Dan Carins, Productivity Lead and Account Manager for BCGH, sat down with Chris to discuss the importance of Cashflow Forecasting and how they can be used as a tool for recovery.
Dan begins by asking, why is Cash King?
Simply - you can’t operate without it
It is the oil that lubricates the engine of business
And don’t confuse Profit with Cash! You can be profitable and short of cash, or indeed be making losses for a period and have cash flowing in (for example from prior period sales that were tied up in debtors)
AS the saying goes: Sales are vanity, profit is sanity - and extending that, cash is reality
Accordingly, cash is important (and even if you have a large amount of it you shouldn’t treat it lightly) and its critical when business is variable and there is limited headroom - a position more businesses are finding themselves in than usual right now.
Compiling a good cashflow forecast is about understanding the working capital of the business and how it ebbs and flows with the level of trade.
Whilst a cashflow forecast is invaluable in planning through a downturn or crisis, more businesses fail on the upturn than on the downturn. The main reason for this is because having been run down to minimum levels during a downturn with cash resources perhaps at their lowest ebb, there is then insufficient finance to fund the stock levels or debtors that grow as sales increase.
How to prepare a forecast
Whilst there are some forecasting packages available to purchase online, in my experience most people still use Microsoft Excel - it is infinity flexible and can be easily tailored to your business. In addition most staff, and certainly all accountants, are familiar with it and it is therefore easily transferrable between colleagues and to third parties as and when required.
So having decided upon your approach , gather your financial data - and it is of course helpful if this is up to date!
The cashflow should be arranged at least by month (typically covering the budget year at least), and we also recommend that businesses maintain a weekly rolling cashflow template - going out for a minimum of 13 weeks - especially in periods when headroom is tight.
Whilst month end balances give an overall picture of cashflow - the devil is usually in the detail - for example, with customers perhaps paying later in the month and not before payroll has to be met in say, the third week. It is important to model this or at least understand the possible impact this could have on the cashflow projected.
It is possible to get an appreciation from the past (potentially from bank statements) - or otherwise by considering the specific timing of certain payments during the month (notably PAYE, Wages), as to how big the overall fluctuation within a month may be.
This can impact the level of funding required that is otherwise based on a month end assessment (and don’t forget the payments that only come quarterly like the rent or VAT)
Otherwise the cashflow should ideally start with an opening balance sheet and roll forward, reconciling to the P&L result that is forecast and the cashflow itself. This is a more advanced integrated model.
The simpler (one sheet version) focusses purely on the likely cashflows.
This will include:
- The opening cash balance and the businesses debtors and creditors. The latter can then either be model ‘on average’ - that is to say assuming they will be collected or paid on average in so many days or alternatively, each individual item can be planned and forecast for a particular week or month. That is particular important where there are any significantly large individual items.
- Future sales, either derived in part from the current order book or best estimates, can be reflected in total, again based on the average time it takes to convert a sale into a cash receipt.
- Payroll and the subsequent periods related PAYE and NICs are easier to determine and reflect, along with other regular overheads (rent, power etc and a list of existing Direct Debits is a helpful reminder of some of the costs and their timing)
Be careful not to overlook any costs or possible one-offs when working independently of the accounting system, or not to miss any unaccrued purchase invoices that have not yet been processed or found their way through your system.
Once completed, as with all projects, challenge it and reconsider it.
So what makes a better forecast?
Firstly, One based on reliable accounts that are kept up to date.
Without that, at best there is delay in forecasting well and otherwise the risk of too much inaccuracy and under-estimation of the cash need.
Secondly and If you can, A fully Integrated version.
Ideally as mentioned previously a fully integrated model is more robust as it cross references or reconciles the Cashflow from the P&L and Balance Sheet, providing the forecast with a level of integrity that a simple stand alone cashflow cannot.
Third - A flexible model and assessment process
A more advanced model will also allow the estimates and assumptions that have been used to be quickly changed so that one can assess rapidly the impact of variations in say debtor or creditor days upon the cashflow and thus, the required headroom.
Being able to demonstrate the sensitivity of the cash flow to changes in assumptions is a powerful tool, enabling a rapid risk assessment and conveys the strong impression to third parties that management fully understand the business and the risks involved.- and just going through that assessment process will certainly help that understanding.
This doesn’t mean that a simple ‘one pager’ can’t provide the necessary insight, although these models will be generally less robust and require careful review after each amendment and more manual editing to test hypotheses.
In any event, whichever forecast is used - produce a ‘Best Case and ‘’Worst Case’ forecast (or otherwise presenting sensitivity analyses) This is not only a good idea for your own peace of mind, but can help defuse challenges from lenders or investors.
Finally - Those Linked to the accounting data (by way of electronic linkage)
Models that are linked, or that otherwise have data uploaded from a sound accounting system are more likely to reflect the businesses current situation correctly and give the projection a sound base. Omissions are less likely and updating them should be easier.
Otherwise there are a number of features that make for a better models and which there isn’t time to go into here, but include building in cross checks on the validity of the data, ensuring ‘input’ cells are clear and distinct from those that contain formulas and include key ratios and graph the cashflow.
How do cashflow forecasts help
Good management information enables you to assess matters more effectively and consequently take better decisions. This includes assessing the risks. Cashflow forecasts are an important part of that.
Anticipating where the business is likely to head as regards its cashflow, enables you to react sooner and more effectively to ‘holes in the road’ - and avoid them, or fill them in.
A client of mine who ran a technology manufacturing business said he didn’t want a model, explaining that they were always incorrect. I told him that if we developed a model for his business that I could guarantee it would be wrong (every time)! He was surprised by that until I explained that was most important was understanding the sensitivity and variability in the cashflow driven by changes in estimates - not the strict accuracy of the forecast.
Cashflow forecasts also help you to first assess and then ask lenders for the right amount. Without a decent forecast you are just guessing and going back to ask for more money later can be very awkward. Likewise, whilst not as critical, borrowing too much can be an unnecessary expense and risks having the request declined.
We once did a forecasting model for a well-known high-street chain. They were about to borrow £8m and thought they should assess that more closely. The financial model developed suggested £3m was sufficient. They actually never need to use much more than £2m.
In planning for a recovery in particular these forecasts can help ensure there are sufficient cash resources to enable expansion or otherwise, prompt a more gradual growth path. (and remember it always takes longer and costs more than you think)
Securing the funding you require is much easier with an appropriate forecast.
Lenders will look for this, assessing its reliability and the extent to which it has been stress tested.
Compiling a ‘Best Case and ‘’Worst Case’ forecast (or otherwise presenting sensitivity analyses) is not only a good idea for your own peace of mind, but can help defuse challenges from lenders or investors.
And finally, before I finish, a few - Thoughts in connection with this recession and some ways to improve the cashflow you’re forecasting:
Usually a small proportion of businesses are having a cash flow challenge at any given moment - this crisis has meant that all businesses are looking to their cashflows and at strategies for managing through this period and beyond
Lenders are naturally somewhat overwhelmed and there are new Government rules to discover and comply with for certain facilities.
Having decent management information and a credible plan for success is even more important than usual in terms of getting into the queue for funding and being successful when you do get there.
In considering short term strategies for conserving cash and enhancing your cashflows I am sure you will be aware of and have considered and acted upon amongst others;
- Furloughing staff or reducing hours or pay
- Deferring VAT
- Seeking also time to pay other taxes such as PAYE and NICs
- Putting in Rental deferment requests to landlords and
- Requesting payment holidays on existing loans
In raising extra funds and building headroom into your forecasts:
There are the Governments various schemes including CBILs and others including some Grants and also the upcoming matching of investment monies injected into start up stage businesses.
Good communication always help and there is considerable goodwill about that can be tapped into. Especially around the potential impact on working capital as businesses emerge from lockdown
It seems likely that credit terms will be tighter. Discussions and good communication with suppliers can help. Consider your own terms and possibly tighten them up.
Ensure you have a robust debt collection process.
Consider a purge on recalcitrant debtors. Work up a firm chasing procedure culminating in legal enforcement – and see it through to action if nothing else works. Claim back the output VAT bad debt relief on debtors that are over six months old. (if you have any!)
Some businesses trading levels have been less affected by the lockdown, especially those operating online. However for all businesses, previously blue-chip customers on the debtor’s ledger may not look so blue-chip now after all. This also needs factoring into forecasts.
Teach sales staff that there are two elements of a sales negotiation, the price and the payment schedule. Make sure the customer understands that the latter is a function of the former and sticks to the terms.
And invoice promptly!
I suspect disaster planning is now going to appear more regularly on some Board’s agendas. Businesses that have good management information and risk assessment have always been seen as a better risk and upon a sale or exit, more valuable than those that don’t. The importance of adapting your business to be as flexible as possible and forecasting well, has never been clearer.
Some businesses already look to operate with a minimum cash reserve headroom. I suspect more will be looking at that in the future.
And remember, as mentioned near the start of this session, cash is as much of an issue exiting a recession as it is going into one - the technology client I mentioned before went into the 2009 recession with a loss of 30% of their sales, cutting staff hours and other costs and requiring short term borrowings of £300k. The recovery saw their business grow rapidly again by nearly 50% requiring funding of closer to £1m. Understanding the cost of rebuilding should not be underestimated and needs to be factored in your cashflow.
I hope that you’ve found my comments of interest and I wish you well in managing your businesses through this summer and beyond. Should you have any questions or wish to follow up on anything I’ve raised then Dan will have the necessary contact details.