Cash is King
By now you may know that all accounting and financial recording is done on an accrual basis. This means that day-to-day transactions are not necessarily recorded on a cash basis or as you would see them on a business bank account. Bank statements normally just provide a snapshot of a business’ daily cash movements. As a result, most business owners and their accountants miss the issue of cash flow.
The only time you will see a cash flow report in most businesses is when a set of financial statements has been drafted and a cash flow statements is presented. The challenge here is that the cash flow statement in the financial statements is on annual historical financial information. This information is only going to show you what has been (i.e. how cash was applied in the business) and not what could be (i.e. a forward looking approach to cash flow.)
Without bringing in anything new, we all know that all businesses need cash to survive. Without cash, businesses can collapse. Without cash, business can fail to meet their day to day working capital requirements and may fail to comply with the revenue collector’s regular and annual payments. This leads to additional compliance costs in the form of interests and penalties.
Already you can start to see where the real challenge here can be. A business can be profitable on accrual basis, but still go under because cash is not properly managed. Another business can make losses and still survive because cash is properly managed.
Why some businesses and accountants do not have cash flow forecasting tools:
- They are busy with compliance work and have no time to consider the impacts cash has on the businesses they provide services
- There is a feeling that cash flow projection is a complex exercise, so daunting that it cannot be done in a normal working day
- Their reporting is historic and not forward looking
- Some business owners cannot step away from their businesses, and they spend a lot of time with admin related tasks
- The business owner is the shareholder, and he feels all he needs to know is on the bank statements.
- Some business owners do not see the value in getting a service provider to help them with a cash flow forecast.
- Once a cash flow forecast is done, no one hold the business owners accountable in terms of what the projections say
- Other businesses and accountants will only do it on demand (for example, shareholders or the bank need it
Why do businesses need a cash flow forecast:
Now that we understand what a cash flow projection is, we can now discuss why cash flow forecasting is important for every business and why every accountant should provide this essential service. A good cash flow forecast tool is essential because it:
- Is great for planning your business activities
- Enables resource allocation
- Ensures that business activities are correctly aligned with each other
- Supports businesses in making sensible, realistic decisions for business
- Gives business owners greater control over their business finances
- Allows businesses to better understand their business performance
- Helps businesses plan for the future
- Helps businesses in determining their value
- Helps business secure funding
- Helps identify and indicate where the business may go into the red and therefore need a cash injection
- Helps identify and show where businesses may have excess cash and therefore help identify opportunities to invest this extra cash
How do you do a cash flow projection:
An accountant may never be able to do a cash flow projection without the input of the business owners. Of course, there are certain things such as forex rate changes, interest rates, applicable tax laws and their impacts on business that accountants will require detailed research. But, business owners will have answers to most of the inputs for a cash flow projection. These could include:
- Major revenue contracts expected in the next few months
- Revenue income sources for the business
- When prices may will be changed (Accountants may help with the costing for business products)
- Planned salary increases and incentives in place for their staff
- The inventory burn rate
- The debtors and creditors payments days/terms
- Anticipated capital expenditures
While it is a good thing for businesses to be ambitious, it is very important to remain realistic in their forecasts. Remember, the business will use this forecast to measure their performance over time or use it to apply for financing with a bank. A too ambitious cash flow forecast may be a recipe for disaster.
It is also important to understand that a cash flow projection is not an income statement projection. Therefore it should also take into account:
- Net cash movements
- And cash items that do not normally appear on the profit and loss such as dividends, tax payments, VAT, loan advances or repayments etc.
Other things to think about are whether some payments and incomes are recurring in nature or of these are ad hoc or once off. Businesses should also take into account seasonality of their products and businesses.
In conclusion, while historic data is useful in some areas of financial reporting businesses are in need of a more forward looking reporting to help them plan and make more sound decisions. Cash is king, it needs to be well managed.