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You may have heard that the biggest cause of business failures is cash flow problems, but how serious is this widespread problem? To put things in perspective, more than 80% of bankruptcies are due to a lack of cash, 20% of small businesses fail within a year and half fail within five years.
But it doesn’t have to be that way. In fact, many businesses can avoid cash flow problems the right way cash flow forecasts. Cash flow forecasts help companies predict when problems may arise and enable them to take proactive action to avoid liquidity shortages.
That said, many businesses are already operating at maximum bandwidth, and cash flow forecasts are not on the minds of business owners. It’s usually too late when business owners are hit by a financial setback and realize they don’t have enough money to cover it.
Many business owners don’t realize that scope of benefits resulting from good cash flow projections goes light years beyond helping the company plan its operations. If you’re still thinking about why you should get into it, here are a few reasons why you should do cash flow forecasting:
Related: Often Overlooked Ways Entrepreneurs Can Improve Cash Flow
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1. It helps companies avoid cash flow gaps
This is the most obvious and important reason why cash flow forecasting is crucial.
Here’s a scenario for you: John’s client promised that the payment would be deposited today, but there was a mix-up and the bank said that John would not get the money until next week. John is expected to pay his salesmen tomorrow, but without receiving payment from his customer, he does not have enough money to pay. The cycle continues.
This is why many companies go bankrupt.
A cash flow forecast helps companies avoid this situation. They can use a forecast to project best-case scenarios, worst-case scenarios, and everything in between. They can then use that to make wise decisions about how much money to spend, where to put it, and when to spend it.
If they think there is a chance of no cash coming in, the company may decide to postpone a major purchase. Or they can talk to suppliers and get a deferral of payment. Or they can give customers a discount to pay their bills sooner. The forecast gives the company the knowledge they need to take action and avoid difficult cash flow situations.
Related: 4 tips for managing cash flow in a seasonal business
2. It helps secure loans
Loans are an important part of running any business. Financing can help a company expand, improve its products and workflows, or cover operational costs in a crisis situation.
However, getting financing is easier said than done, especially for businesses with little equity or no credit history. In this case, lenders look at profitability, costs and cash flow.
A strong cash flow forecast helps a company prove its creditworthiness to lenders. A company can use its cash flow forecast to show it is earning a loan and is a good credit risk. Or, if your cash flow forecast shows otherwise, it might be a good time for you to internally review and improve your cash flow position before going to a lender for a loan.
3. It helps companies make better decisions
A cash flow forecast gives a company a view into the future. It helps them see when money is coming in and going out so they can better plan for the future and make strategic decisions that align with their budgets.
Suppose a company is considering hiring additional staff or purchasing new equipment. A company might research how much money they currently have, assuming they can cover the extra costs. But what if the company loses a major customer in a week? Or what if sales suddenly plummet due to competition?
These are the kinds of things your account balance can’t tell you and are the exact reasons businesses need cash flow forecasts. By understanding their future cash availability, companies can make informed decisions about when and how to invest in their growth.
Related: How to Inflation Proof Your Small Business
4. It helps companies set measurable goals
By using cash flow forecasting, companies can set measurable goals to tangibly improve cash flow and determine the path to better business results.
If a best-case scenario forecast indicates that you could potentially grow your business revenue by 50% by improving your operations with the purchase of new equipment, then you now have a benchmark number.
Or, if you plan to reduce costs by 20% by shutting down parts of your business, cash flow forecasts can help you see the business and revenue impact of discontinuing a project and whether the reduction in financial costs is consistent with your decision. You can now set data-driven business goals, know the outcome to expect, and measure success.
Those are two drastically different examples, but whatever situation your company is in, cash flow forecasting can help a company set measurable goals.
Making forecasts for your business is easier than you think
Here’s the problem with cash flow forecasting: It’s not new, but it used to be a challenging, labor-intensive, and time-consuming job that business owners would entrust their accountants with. The good news is that innovative technology makes forecasting cash flows easier than ever. New tools now integrate directly with many of the cloud accounting platforms businesses use, making cash flow forecasting faster, more accurate, and sometimes even free. Find a solution that works with your accounting platform today and see the wonders it can do for your business.
Janice has been with businesskinda for 5 years, writing copy for client websites, blog posts, EDMs and other mediums to engage readers and encourage action. By collaborating with clients, our SEO manager and the wider businesskinda team, Janice seeks to understand an audience before creating memorable, persuasive copy.