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Good Cash Flow is the Life Blood of a Healthy Business
Good cash flow is the key to the ‘health of the company’ and it is the ‘life blood’ of all businesses, so planning and predicting what will happen and when it will happen is equal to a successful business.
The key is to have the tools to optimize those cash flows and the ability to forecast cash flow and run ‘What if’ scenarios with your ‘Cash Flow Projections’. Having easy-to-use cash flow forecasting software is an essential tool for business owners and accountants working on behalf of their clients to produce professional reports.
When making decisions about how to optimize future cash flows, it is essential to have well-prepared cash flow forecasts that you will review and present to your management or investors or the bank where your company wants to raise funds.
Some key areas to consider when preparing a cash flow forecast are as follows:
1. Forecast Period – Depending on the use of cash flow and profit forecasting will depend on the period for which you need to prepare reports. Normally this would be for a period of 3 years, but in some cases it can be for a longer period and can be up to 7 years.
2. Professional-looking reports – It is necessary to have professional-looking reports, and they should contain at least: cash flow; profit and loss; and the balance sheet.
3. Additional reports – reports in addition to the basic ones listed above include: a report on assumptions that shows the key assumptions used in the preparation of financial forecasts; a page with a summary of forecasts with profitability analysis; a trading summary showing the product lines of the business and related cost of sales; an overhead report showing a complete breakdown of business expenses; report on long-term assets with associated depreciation; credit report showing bank loans, installment purchases and the like; and a VAT/sales tax or GST report.
What if scenarios
Once you’ve prepared your reports, it’s always a good idea to run different what-if scenarios and print out the resulting profit and cash forecasts to reflect the changes in assumptions you’ve made. It is extremely useful to do a sensitivity analysis of your figures to see how your future cash flows could be affected by, for example, a drop in sales of say 10% and so on.
When putting together the figures to feed into your cash and profit projections, you’ll need to look at your current overhead costs and decide how they will change in the future, for example, you’ll know how much your current space costs in terms of rent and property taxes, so it will predict this cost be very easy. However, forecasting your sales can be a bit more challenging, but the associated costs of those sales will be easier to calculate if you want to align them with your current costs.
When deciding on your sales forecast you will need to be able to back up your receivables and certainly if they are higher than last year’s profit and loss then you will need to be able to explain the increase. Similarly, you will need to be able to explain your overheads and any increases or decreases in these figures against your past data.
Profit and loss in relation to cash flow
Make sure you understand the difference between profit and loss and cash flow, for example, if your business is VAT (sales tax or GST) registered and customers take time to pay you because you give credit terms, then the sales amount is included in the invoice profit and loss will differ from the amounts included in the cash flow statements.
Let me explain this with an example for clarity: let’s say your January sales are £10,000, excluding VAT and your customers take an average of 30 days to pay their invoices.
The amount you would include in your profit and loss account for January would be £10,000, while for the same set of sales the amount included in cash flow would be £11,750 (where VAT is 17.5%) and would be included in the month of February. Also, the VAT on this sale would be included in the payment to the Government (where it is paid quarterly) with the sales of the next two months, minus the VAT on the purchase, in the month of April as a cash outflow.
At the end of the day, it is important that your cash flow forecasts reflect what is a realistic prediction of what you think will happen, so that when you present the reports to your management, bank or investors, they have confidence in what you are saying and are therefore happy to invest or lend business money in case this is the reason for preparing these forecasts.
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