Whether you have an established company or are just starting out. Cash flow planning should be part of your financial strategy.
You see, managing a business is hard work. But much of this work often relates to finances, which ultimately translates to how you run your business and for how long.
By monitoring and managing your finances correctly, your company will be able to continue for a considerable period of time.
For a business to not only stay afloat but also turn a profit, its founders need to be aware of all incoming and outgoing expenses.
These expenses, among other things, fall under what is known as cash flow planning, which in turn is part of your larger financial plan and strategy.
Companies that struggle with their cash flow are often those that fail early on.
To monitor your finances and understand how your company is operating, you’ll need to know what cash flow planning is, what it includes, how it impacts your business, and the mistakes you need to avoid.
What is cash flow planning?
“Cash flow is the net amount of cash and cash equivalents being transferred into and out of a business. Cash received represents inflows, while money spent represents outflows,” explains Investopedia.
For businesses to see all of this information and be able to keep up with it, they need a cash flow plan.
“A cash flow plan allows a company to plan its incoming and outgoing cash to ensure it can meet expenses.”
Investopedia
As a business, you need to know the differences between cash flow planning and budgeting.
In the world of finance, budgeting is like forecasting. This means that a cash flow plan would be part of your overall budget.
Companies use budgeting to plan for their future. This way cash flow planning becomes part of the company’s forecast for its operations.
For example, if your financial advisor creates your financial forecast for 2022, part of that forecast will include your budget and cash flow estimate.
A year later, they will revisit the forecast and compare it to the actual data and finances from your company. This will help you as a company and help your financial controller or advisor see if the forecast was on-plan or off-plan and carry out the needed adjustments.
Why cash flow planning is important for businesses
A cash flow plan helps you, as a business, see how much you’re earning and spending, whether it’s general expenses, advertising, salaries…etc.
As a business, the money you get from sales is called ‘revenue,’ whereas anything you spend money on is considered ‘an expense.’
It’s important to distinguish between revenues and profits.
Revenue is the total amount of money generated from selling goods or services as part of a company’s primary operations.
In addition, revenues may come on installments, or time-based deliverables, or in the form of credit terms that may be extended.
Often used interchangeably, ‘revenues’ and ‘sales’ do not include any deducted costs or expenses that are associated with operating a company.
Profit, on the other hand, refers to any money remaining after deducting or accounting for “all expenses, debts, additional income streams, and operating costs,” explains Investopedia.
So, although both profits and revenues refer to money, it’s possible for a business to generate revenues but incur a net loss.
In this case, a business would have a positive cash flow but a negative net income, profit, or bottom line.
If a company enjoys a positive cash flow, this means that its liquid assets, those that can easily be transformed into cash, are on the rise.
Having liquid assets allows the company to pay its dues and obligations, return money to shareholders, cover its expenses, or reinvest in its business.
In addition, having a large volume of liquid assets can help companies by creating a buffer against possible money problems in the future.
An example of having positive cash flow but negative net income can be seen in the income statement of US retailer JCPenney.
In 2018, the company posted a net loss (negative net income) of $78 million. But it also posted a positive cash flow position of $181 million.
How? JCPenney suffered a loss but it got enough cash from loans to offset the loss and result in a positive cash flow.
“Companies with strong financial flexibility can take advantage of profitable investments. They also fare better in downturns, by avoiding the costs of financial distress,” notes Investopedia.
Moreover, part of cash flow planning is financial recording or bookkeeping.
This is where a company becomes aware of how much money it’s getting, when and where it’s coming from, and where it will be spent.
Financial reporting helps companies and startups assess and understand their “liquidity, flexibility, and overall financial performance,” notes Investopedia.
Poor cash flow and failing businesses
Having a positive cash flow allows a business to expand and grow. Whereas having poor cash flow will do the opposite: make the business fail and close its doors.
Many new companies fail within the first five years. While there can be many causes for this failure, the most significant and recurrent is: poor cash flow.
Here are 6 statistics from a study by U.S. bank on the effect of poor cash flow management on new startups and small businesses.
Cash flow planning mistakes
We’ve covered the reasons why you need to have a cash flow and what it means for business.
Now it’s time to focus on the what-to-not-do or the top mistakes small businesses making when they’re doing their cash flow planning.
1. Overestimating future sales
As a new business owner, you should be optimistic. But when it comes to your sales, you need to be realistic.
You need to be aware that you may see seasonal sales increases during certain holidays but you need to be careful with your forecasts.
2. Overspending in the launch phase
The second cash flow planning mistake is overspending at the beginning or when you’re just launching your new business.
It’s a common mistake new entrepreneurs make, thinking that going big means they’ll get more clients or customers.
But the result is that they often run out of cash or funding within a few months or a couple of years.
And while the saying “It takes money to make money” is true, not all expenses are equally important.
There are definitely expenses you’ll need to make to get the business up and running.
But instead of going in headstrong without considering the consequences, get advice from a consultant or advisor who can help you make sound decisions and avoid expenses that might hurt your business rather than grow it.
3. Ignoring past-due invoices
Another major cash flow blunder is having many unpaid invoices from your clients.
Whether it’s because you’re too shy to ask for your money or something is wrong with your money collection process, this mistake can cost you your company.
A great way to overcome this cash flow planning dilemma is to use clear policies with your customers and include penalties for late fees and suspending the work you’re providing if clients don’t pay for within the agreed-upon dates.
4. Not creating a financial buffer
We’ve mentioned that one of the main benefits of having a cash flow plan is that it provides you with a financial buffer for unexpected expenses.
“If your company is working from a zero account balance, one slow sales month could mean instant disaster,” stresses Jared Hecht, CEO and co-founder of Fundera in an Entrepreneur article.
To overcome this problem, you’ll want to have an account balance that provides at least two to three months’ worth of expenses. That way, if any unexpected expenses arise or clients are late in payment, your business will continue.
5. Not keeping up with your cash flow
Following the above-mentioned four points will help you greatly. But not tracking your day-to-day cash flow operations can put you in a tight spot.
Depending on your industry, some businesses may require additional inventory before the holidays, which means they need extra cash to pay their suppliers.
By creating and using a cash flow statement, you’ll be able to keep up with your incoming revenue and outgoing expenses. This, in turn, will help you predict when you may have more outgoing cash than incoming money so you can stay ahead of a cash-crunch.
Getting started with a cash flow plan
Cash flow planning is an essential step in any business. It helps startups stay ahead of their finances, while providing them financial stability for a longer period of time.
But as a business owner or manager, you probably don’t have enough time, or ability, to work out all these expenses and forecasts.
This means you need a financial advisor to help you.
And that’s where Stride comes in.
At Stride Financial Advisors, we help companies like you stay ahead by analyzing existing financial performance and creating financial forecasts including cash flow plans among other services.
Want to learn more about our services? Get in touch with us via the contact form on our website. Got questions about cash flow plans? Leave them in the comments below.
