How The World’s Top CFOs Approach Cash Forecasting

cash forecasting - bookkeeping services

When a lot of time and money is spent on planning, we must also give due attention to its execution.

To illustrate this, let us take a hypothetical example of a hotel that, based on its record, invests $50 million per year in marketing. But if it just leaves this to chance and hopes for the best, it might find itself 100 million dollars short of where it would like to be. And now, we assume nothing about the impact of an earthquake on business, terrorism, natural disasters, or bad luck!

A good way to manage this problem is of course to plan, plan, plan, plan, plan – but unfortunately planning is nothing on its own. What else must be done?

Executing requires the same processes as those identified as management processes and is mainly in the domain of the management of daily operations.

And cash forecasting is a huge factor.

Why is cash forecasting important to your business?

why cash forecasting is important to your business - bookkeeping services

The business world has evolved from the old ‘predict and adapt’ mentality to a far more complex and sophisticated world where forecasting and planning are critical to success.

The challenge for you, the business owner, is to develop the skill of evaluating your cash position, with the aid of your internal planning, and to compare this, time after time, with external factors, in the context of your business strategy.

You must constantly be aware of the key indicators which you are using to measure your success and the factors that will influence the value of your company.

Here’s how you can master forecasting, too!

master forecasting - bookkeeping services

There are at least two types of cash burn rates for any company: those tied to investments and those tied to expenses. While one is typically a direct result of another, it is necessary to have both.

About expenditures, understanding how and when each of these will be paid for will drive your company’s cash forecasting. The team must then translate those expenditures into expected cash requirements.

There are at least three ways to do this:

  1. Top-Line Sales/Cost Approach
  2. Pay-As-You-Go Approach
  3. Breakage Method

There are also two main types of sales: variable (revenue tied to expenses) and fixed (costs that aren’t going to change significantly). These are called two-way adjustments.

Sales, expenses, and profits all represent two-way adjustments. Sales are variable because they are related to how much your company has made on sales. When sales are higher, so are profits. If your company has had problems buying things in the past, profits may be lower than usual, but sales will usually be higher than average. It’s like if you earn extra every time you buy new clothes. If you’re broke, you’ll make out like a bandit buying $200.

As much as people may not like it, when your company has problems buying, profits can be lower or even lower than usual. When your company doesn’t sell things, then profits will be lower than usual. It’s because the amount of sales you have is tied to the amount of money you make.

If you make less money, then even though you can’t buy as much, because your company isn’t making as much money on sales, you still make the same amount as you would if your company made money from sales. If your company makes more sales, then that number is going to affect how much money the company is making.

Sales, expenses, and profits are all related.

So, to build a cash forecast—we recommend utilizing one of two different cash flow methodologies that will help determine how much you’re going to pay each month as a result of the plan’s assumptions.

1. The Level Cash Flow Methodology:

The level cash flow method uses a simple formula, with the results expressed in cash rather than in a discounted value (i.e. the cash flow amount used in your business plan). This simple approach is good enough for cash planning, because it accounts for three main factors:

a. Income

The income part of this cash forecast is pretty straight forward: it’s simply your projected income minus any expenses that will continue to be incurred regardless of whether the business is up and running.

b. Expenses:

What might be a bit more challenging is determining which expenses to consider for cash flow purposes. Depending on your situation, there are a number of variables that may be included here or may be left out of the equation.

At one end of the spectrum is your start-up/pre-opening expenses, which can be pretty much the same as you would charge for your hourly services during the time your business is off the ground. There also might be a one-time payment like a franchise fee that’s paid up-front.

2. Assessing the plan’s sustainability

You may notice a big problem, however. Although your budget’s going to take on water, your house will remain the same. It’s always a tricky issue to tackle because the way you’re thinking about spending and saving goes counterintuitive; what your plan assumes you’re going to do, you may wind up doing.

This is where the budgeting plan’s “sustainability” becomes a real issue because, in the beginning, it seems like you should just borrow enough money to pay for the house, buy all of the furniture, and fill up the garage. But, you can’t borrow more than the total value of the house, furniture, and so on, and we’re going to find that it will take a while for the garage to fill up.

This is called the “asset treadmill” effect. In essence, you’re going to buy new stuff and pay off your old stuff as well as make payments to the bank, and that means that the value of your house is going to go up. When it goes up, your budget plan needs to be rewritten and reevaluated because it assumes you’ll pay less money than what you actually will pay for the items.

But, that’s good, because it means that you can get a mortgage on a much lower value house, like if the house went up 10%, then you pay for it with a bank loan at 10% less than what you owe.

How can BookkeeperLive help your business in cash forecasting?

BookkeeperLive can assist you in cash forecasting by providing information on your business including your financial performance, sales growth rate, and your business prospects.

Our accountants will review financial reports such as profit and loss statements, cash flow statements, balance sheets, and liquidity profiles. We will also assess the viability of the industry in which you operate, your company’s history, and other factors that we believe you need to make a decision about whether to continue operating.

It’s common to become so engrossed in the numbers when calculating profits and financial statements that you fail to notice changes in the company as a whole and the industry. We’ve therefore developed a methodology for giving you useful financial analysis that you can then compare to the rest of the company’s peers to separate the wheat from the chaff and the red from the black. BookkeeperLive provides bookkeeping services at affordable prices.

To learn more about it, connect with us today at hello@bookkeeperlive.com

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