Once marketing positioning and a market niche is well understood the products or services are launched, a new business lives or dies based on cash. Just like a bad injury, a cash bleed-out can kill you.
The concept is very simple, but surprisingly this is one of the top reasons otherwise successful businesses die. Worse, it happens when success causes fast growth, just as it happens because you don't have the revenue to cover costs.
The other big surprise for most business people (and their CPA's) is that regular financial statements do not deal with cash flow. Sure if you ask for one, you will typically get a "Statement of Cash Position," which is NOT a cash flow projection even though it is related.
A cash flow forecast is a plan of when cash will come into the business (spendable money) and when you will need to pay for expenses, payroll and taxes. It involves some basic estimates about sales, payments from accounts receivable, accounts payable schedule and various other cash transactions such as loans, paybacks, tax over payments, and cash spending on new assets.
One reason most accountants don't like to do cash flow projections is that they hate to forecast. Accounting is a precise instrument of what happened. It does not naturally like estimates or forecasting.
For most business owners setting up a cash flow plan or forecast should be done by conservative planning; by themselves. Below is a basic start up cash flow plan.
1. Estimate revenue based on the last 6 months of cash receipts from sales. Use a moving average so if you are growing, this will create a trend for sales. If you have no sales experience yet, the forecast will have to come from your niche market planning assumptions.
2. Estimate average expenses for each month to be paid in that month.
2. b If you buy goods to resell, you must calculate an "Open-to-buy" plan*
3. Calculate payroll for the next several months by week
4. Add bank balance for the day you are starting the calculation.
5. Plan when you will pay for extraordinary purchases such as equipment.
Place 1. on the revenue line in a spreadsheet.
Add 4. to this number in the first column
Subtract 2, 3, and 5
This will provide a very basic cash flow plan.
Update this weekly by replacing estimates and forecasts with the real numbers.
Notice if your cash balance is trending down or up; if down, start early to make the changes to each component so you don't run out of cash. Plan to pay all bills on time, faithfully.
* An open-to-buy plan is a forecast on how much inventory you will need to keep your sales growing. Some industries like fashion retailing can require buying 10 months out, so this becomes a big issue if you miss-buy. Since few people know how to do this, many businesses over buy, which puts a huge pressure on paying bills. This results in mark-downs, whcih puts pressure on profits. More on open-to-buy in a future blog post.