How to control cashflow

Every year, thousands of otherwise viable firms go under because they run out of ready cash. However, crises like this are entirely predictable. Here's how to peer into the future and stay in control.

Cash is not the same as sales and customers don't usually pay you until long after you've had to pay for wages, stock and materials. Other demands, like VAT, seem to build up then hit you with a bang. Unless you've put aside sufficient cash for these, you're in trouble.

The solution is to plan ahead and forecast the flow of cash in and out. It is actually surprisingly easy to do this.

Plan ahead

Very simply; cashflow forecasting is the process of estimating all incoming and outgoing cash, and converting this into a month-by-month projection. Lay out a simple grid with columns across for the next twelve months and list down the side your income and expenses. Total these for each month to see your net inflow and outflow.

Spreadsheets lend themselves to cashflow forecasts but you can also do them on paper. If you use a spreadsheet package, do some back-of-the-envelop checks to ensure your formulae are correct. Many banks have suitable ready-made paper forms you can use or templates for spreadsheets. Forecasts rely on your knowing when cash comes in and when it goes out:

Cash in

Put down your current cash in hand or in the bank. List all the money that you expect to receive this month totaled under headings like cash sales, credit sales, cash injections. Remember, we are talking about cash not sales. So include income due from credit sales made in previous months. Exclude orders in hand and invoices waiting to be paid.

Now repeat the process for each month, again working with expected actual income rather than orders. Take your sales projections and allocate how much will be paid at once, and how much one or two months later.

Don't worry too much about being exact. The further ahead you forecast, the vaguer estimates become. Most businesses just need a fairly accurate two-month figure and a rough twelve-month forecast. Lenders may want to see a two-year summary.

Cash out

Now list your outgoings for this month. Some things are predictable: rent, lease payments, wages, drawings (for your personal expenses) and National Insurance; also list outstanding invoices due for payment from previous months.

Charges for variables like phone bills and post are slightly harder. If you have no previous figures to go on, make a realistic guess. List other expenses you will have to pay cash for this month. (Items bought on credit or with a credit card will appear next month.) Extend these figures for the following months as best you can. Remember VAT, which will depend on projected sales.

Stock up

Next calculate what you will need to pay for stock or material and when, again based on your sales projections.

Now comes the fun bit. Add up the first month's outgoings and subtract them from receipts. This shows your cash surplus (or deficit) for the month. Add this figure to the cash-in-hand to give your expected cash position at the end of the month. Repeat this process for each month. Warning signs are continuing deficits and a negative cash position.

Judge your income. Planning your sales levels requires market research and past experience. Err on the side of caution. Sales will also depend on your marketing efforts, staff levels and production capacity. These all involve cash outlay before any income comes in.

Record any assumptions you make in your forecasting, such as how long you expect customers will take to pay you. If you offer 30 days' credit but they take around 45 days to pay, your figures will be badly out and you may not have enough cash to keep going until you receive those outstanding payments.

Cash is not profit. If you buy something for £50 and sell it for £60 you make £10 profit. If you pay your supplier in June but do not sell the product until September, and then don't get paid until mid-November, you have a £50 deficit for five and a half months. That £10 profit could have been eaten up in overdraft interest. That's why fast, under-capitalised expansion can be fatal. Many a business fails despite a full order book.

Big payments

Your cashflow forecast is a big help to manage big, one-off payments, like your insurance premium or tax bill. These may fall in your low season, when cash is short, so you must put money aside for them. Remember why you're doing it. A good cashflow forecast will reduce one of the biggest threats to your business and greatly increase your chances being around this time next year.

Preparing a cash flow forecast and then keeping it up to date may seem like a chore but unless you are prepared to spend a little time and effort doing this then you will have no idea where your business is heading and you won't know that there is a problem looming until it hits you. You need to see what is ahead so that you can direct your business successfully.

After all, would you drive along a road with your eyes closed?

Click here to see how the cash flow of a typical pharmacy works