Maintaining a healthy cash flow is critical to the growth and operations of every business, no matter its size. Gaining an understanding of your cash flow is not as complicated as you think. This simple model can help you predict your company's cash flow.
Start by taking a look at the cash flow statement generated inside the accounting application you use. Look specifically at the money that has come in and the money you have paid out across a month to see what has changed. Another simple way to do this is to look at your bank statement to see if you had more or less cash at the end of the month or at the beginning.
“Cash flow is the most important part of a business. Without the cash flowing you can’t operate, so getting cash flow right is essential,” says Brad Callaughan, director of accounting firm Callaughan Partners.
To begin, forecasts will be driven by assumptions that are appropriate for your industry or business. “In your first year, to work out your expected cash flow, turn to industry statistics and benchmarks, dealings with customers and suppliers and your own knowledge of your industry. You will also need to factor in seasonal trading. You can use real data from your second year onwards.”
Here's how to make simple calculations to quickly track your cash availability for the coming month.
Your company's inflow
These are the activities that increase cash flow inside your business.
A profitable business generates cash flow for the company over the long term. If sales exceed overall expenses, you will eventually have more cash to reinvest or pay out to the shareholders.
A decrease in accounts receivable
When fewer customers owe you money, this typically means they have already paid for your product or service and that cash is available inside your company to use.
An increase in accounts payable
When you take additional time to pay your own bills to vendors, you keep the cash inside your company longer. This is similar to how you use a credit card – you get the product immediately, but can pay for it with cash 30 days from now.
A decrease in inventory
All inventory you buy needs cash to pay for it. The less inventory you have, the less cash it consumes. This, of course, needs to balance how much inventory your customer requires so you can deliver orders to expectations.
A cash loan
Any loans you receive from outside financing sources add to your cash. But remember, loans need to be paid back eventually with future cash flow.
Your company's cash outflow
Outflow refers to activities that decrease cash flow inside your business.
When expenses consistently exceed sales revenue, eventually you will run out of the cash that is needed to cover these losses.
An increase in accounts receivable
When this increases, it means more customers are paying you later and you don’t have the cash now. Typically, you must pay for the cost of these sales before the customer pays – meaning cash is going out before coming back in to cover these expenses.
A decrease in accounts payable
This happens when you are paying bills more quickly or new vendors are giving shorter payment terms than existing suppliers.
An increase in inventory
This either means that you are stocking more inventory or customers are buying less or not what you thought they would. Either way, more cash is invested in your inventory.
Paying down financial loans
Any loan that needs to be paid back from borrowed capital reduces your cash to be reinvested or paid out to the owner.
Predicting next month's cash flow
Once you know what affects the inflow and outflow of cash in your company, you can start to predict how much cash you will need or have in the bank at certain planned time periods.
This can be done in a very simple and manual way.
- Open an Excel spreadsheet and list your current cash in the bank.
- Subtract from this cash balance any payment sent, but not yet cleared against the bank account.
- Add any cash from accounts receivable and sales that you forecast you will collect next week.
- Review your accounts payable for any bills you need to pay next week and subtract this from the total.
- Then, subtract any cash that needs to be paid for inventory or other capital purchases that are not in accounts payable.
After these calculations are made, you will have an estimate of what your cash balance will be for the following week. For example:
Cash in the bank balance: $20,000
Minus payments not yet cleared: $6,000
Effective cash balance: $14,000
Plus accounts receivables and cash sales: $23,000
Minus accounts payable bills to be paid: $19,000
Minus other inventory/ purchases: $3,000
TOTAL ESTIMATED CASH: $15,000
Repeat this calculation for the following four weeks, while keeping in mind any seasonal expenses that may become variables for that fixed period, and you’ll be able to work out next month’s cash availability.