When pressed to single out the most important touchstones for any business, many entrepreneurs cite customer experience, profitability and competitive pricing. Cash flow, however, should be at the top of that list as none of those other activities are possible without positive cash flow.
As anyone with a profitable bottom line knows, profits don’t equal cash flow. Cash is required to keep business operations running, making cash flow forecasting central to understanding your operating cycle. With effective forecasting, you can better manage cash inflows and outflows.
Smart Business spoke with Douglas V. Wyatt, executive vice president, senior commercial banker at Fifth Third Bank, to learn more about cash flow forecasting and its role in business operations.
What is the key to maintaining positive cash flow?
The key to maintaining positive cash flow is predictability, which requires situational awareness of your operating cycle. That can be achieved through cash flow forecasting.
While there are certainly complex and costly models for cash flow forecasting, a spreadsheet is a tried and true method. The process begins by entering your cash on hand, reviewing your receivables aging for past due invoices, then, based on recent payment history, you can estimate when you will be able to collect the funds owed to you. This analysis will allow you to see how many customers pay on a timely basis and how many are paying beyond the set terms.
How might quality issues impact cash flow?
There is a link between operations quality and finance. Some businesses grow so rapidly that delivery processes begin to lag. This can result in a poor customer experience, which in turn creates a negative cash flow situation if customers begin withholding payments because of degradation in the quality of service. Examine your processes to understand if there have been changes that impact quality that could influence your customers’ desire to pay on time.
Some businesses can be too flexible when it comes to billing. This can lead to invoices or final bills that don’t match the quote or purchase order (PO). When a customer requests a format change to your invoice, this can create a problem for the person whose job it is to match the quote or PO with the invoice. As result, they can’t easily make the connections, which in turn can cause a delay in payment and negatively impact the customer experience. To avoid this scenario, talk with customers to better understand their needs and clear up any related issues.
Why is it important to develop a disbursement strategy?
Putting in place an effective disbursement strategy to pay vendors is critical. Use of a PO system can help control expenses before the purchase takes place. POs allow you to set parameters indicating what products or services someone can buy and how much they can spend without additional approval. POs can also help a business stay on top of cash outflows and show when expenses will hit the books.
Payments via an electronic payables solution or a purchasing card program are also highly effective ways to manage the timing of cash outflows. Using such payment methods, you can schedule payments and achieve greater predictability into when funds leave the organization.
How can situational awareness be achieved?
When forecasting cash outflows, it’s important to look at when the cash flows out as opposed to the total amount of the invoice. Start the cash forecasting with your cash on hand, then add the realistic expectation of when cash will be received. Subtract the cash expenditures and the resulting number is the net cash available for the next period.
Don’t be discouraged if the numbers aren’t positive at first. It will take time to develop true situational awareness. But once accuracy is achieved, you will gain deeper insight into your operating cycle, which will have a dramatic impact on your business.
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