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Why every business needs cash flow forecasting

Author: Wayne Searle, Managing Director, ESP Business Solutions

Running your business, you may feel that looking at what has already happened is the best way to project what will happen next. In reality, it’s not the best way to operate. Looking ahead to the future with the help of the present will give you a solid idea of how you’re performing, and where you need to focus. You need to be sure that more cash is flowing into your business than flowing out, and you’ll only know this if you forecast.

When you’re operating day-to-day, and have plans for your business to stand the test of time, you need to be forecasting both short and long-term. To bring this right back to basics, here’s a quick breakdown of the differences you’ll see with these different time frames.

Short-term forecasting

If you’re looking to the short-term future, perhaps a year or under, then you’re just looking at what will happen immediately. A great example of a short-term forecast which would last a month or two is in retail. Let’s say you’re putting on a sale to get rid of some of your old stock. You’d put the new reduced prices into the forecast to see how much revenue you’d get from it, for example.

Long-term forecasting

Longer-termed forecasts will include such things as economic peaks and troughs, inflation and politics. Because we can never know exactly what will happen next – think Brexit and Trump – creating a long-term forecast will only ever be a guess. However, because you’ve created one it’ll help you to think outside the box about where the economy may be, and how you’ll build your business to the point it can withstand these changes.

It’s like if you were going for a job interview. You’d plan your short-term by preparing for the questions, sorting your smart attire and journey to the offices, etc. Many people may not see past the interview itself, focusing all of their energy on charming the interviewers and making themselves come across well, but what if you do (or don’t) get the job? You need to have a contingency plan for both: if you don’t get the job it’s back to the hunt, but if you do then you need to be ready to excel in the role and fit in well with the team. Thinking of this in this way is easy to relate to, but you need to be thinking in this short/long-term way otherwise you’ll back yourself into a corner.

But back to (your) business. You’re running your company well, but how do you know how you can achieve sustainable growth? How do you know if each and every employee is working to the best of their ability? Do you know what you’d do if X, Y, or Z happened?

Long-term growth

To grow sustainably, you need to have a really deep understanding of your figures. This can only happen if you’re constantly checking in with the ins and outs of your accounts, and forecasting for different eventualities. You’ll know when you’re due to be paid, when you need to pay out to suppliers or similar, and can adjust if need be.

In some industries, like manufacturing, a lot of costs can occur up front, so knowing you have enough cash for this before you’ve even sold anything is crucial. Similarly, invoice payments can be delayed and sometimes you simply won’t get your money on time. People conveniently forget to pay, go into administration or whatever else, so having a backup plan for such things is imperative. Using your forecast, you can add scenarios (more on those shortly…) to ensure you have a ‘plan B’ for these kinds of problems.

Hopefully, you’ve hit a point (or are approaching a point) where you’re feeling ready to expand. This may come in the form of taking on new premises, or hiring a new member of staff, or perhaps investing in some new kit. All of these are intended to impact your bottom line for the better, so when you are looking to do so, you need to know you can afford them.

So let’s use the new hire as an example. You need a new person to take over a few roles within your business, and think you can afford to hire straight away. Studying your forecasted figures in the long term is going to indicate whether or not this is a good plan; look at your sales figures and how they’re expected to look for the long-term. This will show you whether or not the investment in a new hire is going to be worth it, and if anything went awry if you could still afford it.

Add scenarios

So as mentioned earlier, adding scenarios is going to give you a lot more flexibility with your decisions. When you’ve created your long-term forecast, you can add a base scenario with best, middle and worst case results. In the long-term, you could plug data such as inflation, or political changes therefore giving you an idea of what could go really wrong – or right.

As you plan for different outcomes, you’ll notice your business looking stronger and ready to cope with anything the world throws at you. Imagine a very basic example: you want to buy new equipment. You’d want to know that, firstly, you’d have enough in the bank, and, secondly, that you’d get a good return on that investment before you went ahead with the purchase. Using scenario planning you can, as previously mentioned, see your best, middle and worst cases, built on top of your base scenario. You’re going to notice that these various outcomes allow you to prevent negative occurrences, rather than have to cure them.

You’re able to make life-changing business decisions with confidence: look to the future and ask yourself where you want to be next year, the year after and in 5 years. In all likeliness, you’re spending most of your days fire-fighting, but scenario planning will see this become less and less necessary. It’s there to help you navigate the uncertainty.

KPIs: a granular view

So your long-term forecast is going to show you where you could be. Measuring key performance indicators is a great way to see how you’re going in the present, so now try making them key predictive indicators. The difference, as you’ve probably guessed, is that you’re looking at what might happen, instead of looking at what is happening. This is a great way to operate, forcing your head into what’s next

They’ll give you a granular view of your business, by department, even by employee. You’re giving yourself a good view of your team and how things should be. Similarly, if your key performance indicators flag up an underperformance in a certain area, your predictive target can be to combat this issue. You can use them almost like an internal benchmarking tool.

Get a competitive advantage

While forecasting can mean the difference between open doors and a padlock on the forever-closed premises which was your business, it can also take your business from being good to great. If you think about who your competitors are, and feel they always seem to be one step ahead, the chances are they’re forecasting their figures. You can easily overtake their lead by using a forecast, as each decision you make will be well thought out, and made with confidence.

How to get started

If you’re reading this thinking, ‘when on earth will I find time to do all this?’, then don’t fear.  We will work with you every step of the way, from identifying your key predictive indicators, building reports that monitor and forecast your business to driving the insights that take your business from good to great.