The Cash Flow Forecast
IN CHAPTER 7, WE DISCUSSED items that that have a direct impact on the profit and loss and cash flow. In this chapter, we will be discussing items that have little or no impact on the profit and loss of the business but a profound impact on the cash flow.
I MADE A PROFIT; WHERE'S THE CASH?
As you know, most entrepreneurial companies may not generate sufficient cash flow, to operate the business, from the normal operating activities of the business. This often results from an increase in accounts receivable (uncollected sales or customers not paying on time), and/or an increase in inventory (overstocking or a slow down in sales). In addition, the company may need to put down payments on equipment, and pay their suppliers faster then the company gets paid from their customers etc.
NO FUNDS AT ALL
In addition to the above, another major reason for a lack of cash is an inadequate investment by the entrepreneur when the business was started. I have seen this countless times. Overconfident entrepreneurs thinking they can start the business with a small investment or starting a business with no funds at all.
This could be a result of inadequately forecasting or predicting the cash requirement of the business during the formation of the business'a crucial mistake.
Because of insufficient cash from business operations and an inadequate original investment in the business, the business more likely will rely heavily on its ability to borrow. Your banker will become your best friend.
Borrowing: Generally, there are two types of borrowing that an entrepreneurial company will be involved with: Term debt with a monthly scheduled pay back and/or a credit line which will be based on some level of an asset or asset balances.
Term debt will usually be based on the purchase of equipment, and is not usually considered as funds that are available for running the business on a daily basis (working capital). If there is a need for working capital, it should be considered in connection with a line of credit. For cash flow forecasting purposes the term debt will be forecasted when the funds will be needed or the forecast will be used to develop what the needs are.
Each month of the forecast must reflect the pay back of any term debt being used.
The line of credit for you will be the lifeblood for the operation of the business. For your banker the line of credit will be viewed as if they are investing in your company the cash that you never began the business with. To protect themselves they will place restrictions and/or milestones that must be met to continue the relationship. The forecast you prepare will be a great in helping you understand whether you will be able to meet your lenders restrictions or not.
The credit line amount available will oftentimes be based on the level of your accounts receivable. For example, your accounts receivable at the end of the month is $150,000. If the bank will loan 70 percent of the balance, then $105,000 is available. If in the next month your receivables are $120,000 with the 70 percent borrowing rate, the amount available is $84,000. The bank will expect a pay down of $21,000 ($105,000 - $84,000). To forecast this type of activity, the monthly balance of the accounts receivable must be forecasted. This is an important reason the forecast of the balance sheet becomes so vital.
As I have indicated on several occasions, the forecast of cash flow is complex and is many times passed over because of its complexity. Good news: The software I have developed does it all. If the cash flow forecast is not prepared, then you will never know in advance how much cash you will need and when you will need it.
Loans from others: If you have a friend or relative who is willing to fund the business, this should be forecasted as to when the funds will be available and when they will be paid back. Do this for each month of the forecast.
Purchase of equipment: If you are planning to buy equipment during the forecasted period, plan it in advance. It will affect cash balances (down payments) and debt financing.
Dividends: Most entrepreneurial companies if incorporated will not pay out dividends to shareholders. The exception will be if the company files its tax return as an S corporation. By the way, speak to your financial advisor as to whether it is appropriate to file as an S corporation. Without getting into details, there may be some important advantages in doing so. If you do expect to pay dividends, forecast the expected amounts on the dates anticipated. The dividends can be a big drain on the company, especially if you're profitable S corporation and the shareholders need money to pay the tax on their share of the S corporation earnings.
Interest on cash balances: If your cash balances are slim, don't forecast this item. If they are substantial, it may be appropriate to do so.
Estimated tax payments: As you know, the payment of income tax can be quite burdensome on a company's cash flow. Actually, it can be awful. Especially when the business shows a profit, it will be required to pay tax even though the cash may not be available (too high accounts receivable and/or too much inventory). This item must be included in the cash flow forecast. Contact your accountant for the amounts to include and for the proper due dates.
IN CHAPTER 7, WE DISCUSSED items that that have a direct impact on the profit and loss and cash flow. In this chapter, we will be discussing items that have little or no impact on the profit and loss of the business but a profound impact on the cash flow.
I MADE A PROFIT; WHERE'S THE CASH?
As you know, most entrepreneurial companies may not generate sufficient cash flow, to operate the business, from the normal operating activities of the business. This often results from an increase in accounts receivable (uncollected sales or customers not paying on time), and/or an increase in inventory (overstocking or a slow down in sales). In addition, the company may need to put down payments on equipment, and pay their suppliers faster then the company gets paid from their customers etc.
NO FUNDS AT ALL
In addition to the above, another major reason for a lack of cash is an inadequate investment by the entrepreneur when the business was started. I have seen this countless times. Overconfident entrepreneurs thinking they can start the business with a small investment or starting a business with no funds at all.
This could be a result of inadequately forecasting or predicting the cash requirement of the business during the formation of the business'a crucial mistake.
Because of insufficient cash from business operations and an inadequate original investment in the business, the business more likely will rely heavily on its ability to borrow. Your banker will become your best friend.
Borrowing: Generally, there are two types of borrowing that an entrepreneurial company will be involved with: Term debt with a monthly scheduled pay back and/or a credit line which will be based on some level of an asset or asset balances.
Term debt will usually be based on the purchase of equipment, and is not usually considered as funds that are available for running the business on a daily basis (working capital). If there is a need for working capital, it should be considered in connection with a line of credit. For cash flow forecasting purposes the term debt will be forecasted when the funds will be needed or the forecast will be used to develop what the needs are.
Each month of the forecast must reflect the pay back of any term debt being used.
The line of credit for you will be the lifeblood for the operation of the business. For your banker the line of credit will be viewed as if they are investing in your company the cash that you never began the business with. To protect themselves they will place restrictions and/or milestones that must be met to continue the relationship. The forecast you prepare will be a great in helping you understand whether you will be able to meet your lenders restrictions or not.
The credit line amount available will oftentimes be based on the level of your accounts receivable. For example, your accounts receivable at the end of the month is $150,000. If the bank will loan 70 percent of the balance, then $105,000 is available. If in the next month your receivables are $120,000 with the 70 percent borrowing rate, the amount available is $84,000. The bank will expect a pay down of $21,000 ($105,000 - $84,000). To forecast this type of activity, the monthly balance of the accounts receivable must be forecasted. This is an important reason the forecast of the balance sheet becomes so vital.
As I have indicated on several occasions, the forecast of cash flow is complex and is many times passed over because of its complexity. Good news: The software I have developed does it all. If the cash flow forecast is not prepared, then you will never know in advance how much cash you will need and when you will need it.
Loans from others: If you have a friend or relative who is willing to fund the business, this should be forecasted as to when the funds will be available and when they will be paid back. Do this for each month of the forecast.
Purchase of equipment: If you are planning to buy equipment during the forecasted period, plan it in advance. It will affect cash balances (down payments) and debt financing.
Dividends: Most entrepreneurial companies if incorporated will not pay out dividends to shareholders. The exception will be if the company files its tax return as an S corporation. By the way, speak to your financial advisor as to whether it is appropriate to file as an S corporation. Without getting into details, there may be some important advantages in doing so. If you do expect to pay dividends, forecast the expected amounts on the dates anticipated. The dividends can be a big drain on the company, especially if you're profitable S corporation and the shareholders need money to pay the tax on their share of the S corporation earnings.
Interest on cash balances: If your cash balances are slim, don't forecast this item. If they are substantial, it may be appropriate to do so.
Estimated tax payments: As you know, the payment of income tax can be quite burdensome on a company's cash flow. Actually, it can be awful. Especially when the business shows a profit, it will be required to pay tax even though the cash may not be available (too high accounts receivable and/or too much inventory). This item must be included in the cash flow forecast. Contact your accountant for the amounts to include and for the proper due dates.