Like the food we eat every day, businesses are built to consume cash, whether or not they growing. Cash flow forecasting is one of the most important aspects of financial management, but for many business owners it is daunting. Without a finance or accounting degree, it can take considerable research or experience to understand the best way to manage cash. Over half of businesses fail because of cash flow problems.
For many businesses, investment and financing are tied directly to a company’s proven ability to generate cash. Yet, cash can be tough to predict. And there are many ways this process can go wrong, or even damage your organization. Below are five of the most common errors businesses make when forecasting cash flow.
1. Under-committing. Cash flow forecasting is one of the most important business management tools. It requires attention, so it should be allotted sufficient time and resources. It is generally not a good idea to delegate this task to junior-level employees who might lack the understanding of company finances, or overloaded senior staff who lack enough time to dedicate to the task. Cash flow forecasts should be in the hands of skillful management with knowledge of the company’s history and industry. Consider making this process more efficient using cash flow technology.
2. Inaccurate data. It is important to update your projections every time something happens in your business that affects cash flow. This should be a minimum of once a week. Regularly compare your actual numbers with your prediction so you can make necessary adjustments. It is unrealistic to expect a perfect cash flow projection at first; however, if you review your actual results with regularity, little significant variance will occur.
3. Lack of communication. Avoid operating within a vacuum and include all members and areas in your organization when creating a forecast. Developing these communication channels is key to creating an accurate cash flow projection. Staff and members of the management team should review the tentative projection and ensure that their initiatives are included.
4. Not considering different scenarios. One of the primary dangers of cash flow forecasting is overestimating sales. If your sales projections are too far off, this could lead to a cash shortfall. On the flip side, organizations tend to underestimate the occurrence and impact of negative events, making it difficult to recognize and plan accordingly for potential “worst” case scenarios. You should always draft cash what-if scenarios and put them to the test to better prepare for potential positive and negative impacts. Projections should be supported by past experience and ample research.
5. Late loans. If you think you are going to need a loan, it is better to get one early. A strong cash flow projection will show a loan officer that your business is a good credit risk and a good candidate for a short-term loan or line of credit. People tend to overestimate the availability of loans, grants, credit and equity, and this can have a devastating impact on your business down the road when you find you do not have enough funding and the bank will not offer your company any grants or loans.
It is important to keep a close eye on your cash flow and forecast as realistically and exhaustively as possible. Everything affects cash flow in a small business, and without it, your business can not survive. Cash flow projections are one of the most essential and effective tools an organization can create. Make sure it is at the top of your priorities to ensure your business runs smoothly and has the sufficient funds to continue.
Lexy Garrett is a marketing manager at Sageworks, a financial information company that provides financial analysis and cash flow applications to business owners and their accountants. As part of the business advisory technology division, Lexy regularly creates content on improving cash flow for small business owners.