By: Danny Bradbury

You have a profitable side gig that you’d like to turn into a full-time business. When should you quit your job and commit all your time to it? Your small bakery needs equipment to increase production. Can you afford it? Your marketing agency is signing new clients and you need help to manage them. When should you hire more staff, and how much can you afford to pay them?

These are just some of the questions that growing businesses face, and they can’t hope to answer them properly without one of the most important financial puzzle pieces: a proper cash flow forecast.

Cash flow tracks money in versus money out, and how much money is left. It can help you predict how much cash you may have on hand in the future. It’s something that financially literate individuals do every day at home, but in small and medium-sized businesses it’s a rarer skill than you might think.

CB Insights, which analyzes startup data, read through the postmortems of 101 failed startups. The second biggest cause of their demise was that they ran out of cash. This contributed to almost one in three (29%) of startup failures.

Cash flow is especially important for businesses in this financial climate. In 2016, trade credit insurance and collections firm Atradius surveyed 856 businesses in the US, Canada, Mexico and Brazil that dealt with business-to-business (B2B) sales in the manufacturing, distribution and services sectors. Around one in five businesses in the US, Canada and Mexico cited maintaining cash flow levels as the biggest challenge to business profitability, the report said.

Taming your cash flow forecast

How can small businesses get better at this critical financial skill? Creating a forward-looking cash flow prediction involves looking at your prior income and expenses to predict them in the future. Scrutinizing these figures may reveal trends you hadn’t noticed before. Perhaps business dips during the summer, for example, or when there’s an uptick in the fall.

Business owners can use these figures to plot future income and expenses, adding in extra information that might come via a few rounds at the golf course. Perhaps a client reveals that they are cutting back business or offering more work, or the price of key components is set to increase. A well-informed business owner can factor information like this, along with expected business growth, into the figures.

These figures live in custom tools that forecast future cash flow by manipulating ‘what if’ scenarios. They can range from simple spreadsheet templates such as these from the US Small Business Administration to rudimentary statement of cash flow functions built into accounting tools such as QuickBooks.

Other tools, including Float and DryRun, offer potential solutions that integrate with some existing accounting packages to provide more comprehensive cash flow forecasting options.

Best practices

Tools alone aren’t enough to guarantee a healthy cash flow, though. There are some other key recommendations to help businesses ensure they have enough cash on hand.

One of the biggest is managing accounts receivable, ensuring that clients pay on time. Aside from diligently chasing payments, this also means being realistic about credit terms. A large client offering enough orders to account for 20% of your business might seem appealing, but if the company insists on 120-day payment terms that may leave you holding significant debt, then you’re effectively paying to finance their business. If the effect on cash flow puts your own company in jeopardy, that may not be a sale worth taking.

The second key skill for those businesses that carry stock is inventory management. Businesses must typically pay for inventory before they sell it, meaning that it sits there soaking up cash that you could use elsewhere in the company. Try to minimize your inventory turnover to help keep your assets liquid.

Cash flow management isn’t rocket science, but it does take some attention to detail and executive time. Do it properly, and it can help you to consistently monitor the pulse of your business. It can also help you when talking to the bank or investors about financing, especially if you know your numbers.

About the Author 

Danny Bradbury has been writing about technology and business since 1989. His clients have included the Financial Times, the Guardian, and Canada's National Post.

All content provided herein is for educational purposes only. It is provided “as is,” and neither the author nor Office Depot warrants the accuracy of the information provided, nor do they assume any responsibility for errors, omissions, or contrary interpretation of the subject matter herein.