Empty bank accounts and empty promises to your employees or shareholders... If you've ever had the unpleasant experience of having a shortfall of revenue while running your business, you don't need to be told how important a cash flow analysis is. You know.
But just because you know it's important to have a thorough cash flow analysis doesn't mean your projections are correct. In fact, your numbers could be way off. You are, after all, trying to guess the future—and even the biggest and most successful companies get it wrong sometimes. Here are a few red flags you can look for that may indicate your cash flow analysis isn't what you think it is.
1. You are overly optimistic about when your clients will pay you in your cash flow analysis.
Are you often surprised that clients or customers aren't paying you on time? Do your late clients hurt your business because you were counting on that income?
You may want to start hoping for the best and planning for the worst. That's because while you often know when money is going out, you don't always know when money will be coming in, says Richard Hayman, who runs the Hayman Consulting Group in Potomac, Maryland, a CEO mentor and coaching firm. He cites "predetermined items," including payroll, rent, insurance, utilities and taxes, as expenses you can count on.
—Nick Braun, CEO, PetInsuranceQuotes.com
"Where the analysis falls apart is on the increase cash side, basically invoicing and payments from clients and customers. Revenue levels and timing of payments are often just best guesses," Hayman says. "The problem is that best guessing is almost universally too optimistic. A very simple solution is to add 30 to 60 days to when payment is expected. This will help determine cash reserves and give more time to adjust when the best guess is not good enough."
While building in extra time for clients to pay you may not be optimal, adjusting how you get paid may help you operate in your reality. Building in discounts for clients to pay you sooner may not help. You may want to build in a late fee, or you may need to consider dropping a deadbeat customer.
2. You have been struggling with your inventory.
If you have inventory problems, you may be creating future cash-flow problems, according to Matt Fiedler. He is the CEO and co-founder of a company called Vinyl Me, Please, headquartered in Boulder, Colorado.
"One of the biggest mistakes I made as a first-time entrepreneur was mismanaging inventory," Fielder says. "We had previously had a few issues related to our inventory not being delivered on time. We’re a record of the month club, so a month without a record makes it hard for us to stay in business."
So Fielder, as he puts it, "overcorrected" and made sure he had enough inventory for nine months.
"We estimated a relative growth compared to the rest of the year, but didn’t assume that things like churn and seasonal activity would have any impact on us," he says.
It did, and in August 2015, his company had some cash-flow problems. According to Fielder, it was nothing too serious, though some bonuses for his then five employees had to be delayed. Now, a year later, his company is much stronger and he's learned a valuable lesson about inventory and cash flow analysis.
3. Your accounts receivables are abnormally high.
It may sound like a terrific problem at first, and maybe it can be: You're owed far more money than usual. Some may think, Maybe business is suddenly booming, and this is a sign of good times to come.
But high accounts receivables may also be a sign that your company may soon be scrambling for cash.
If you're owed a lot of money, perhaps you are being too slow in collecting it, says Nick Braun, CEO of PetInsuranceQuotes.com, a pet insurance agency in Columbus, Ohio.
Being too slow in collecting your money may lead to regret if your expenses pile up while your revenue doesn't.
Braun says that having a dashboard software program to help with his cash flow analysis has really helped him.
"Our accounts receivable balance is consistent, but over the past five years, using our dashboard, we found that some companies were slow paying us," Braun says. "In most cases it was because there was turnover or some other administrative changes, but these red flags were easy to spot each month and I focused on them."
These three red flags aren't the only indicators that something could be off on your cash flow analysis. If you're studying the numbers and there's something you can't explain, you may want to find the explanation to help avoid trouble down the road.
"Cash is king. It's the lifeblood of any business, but especially small business," Braun says. "A miscalculation, bad month or unexpected downturn can shut your doors if you don't manage your cash properly."
Read more articles on managing money.