Here’s how you can keep an eye on your cash flow to ensure more stable growth.
Accurate cash flow forecasting is essential. Cash is king, especially in a small, fast-growing business that may not yet be profitable. Staying on top of your cash flow helps you figure out how long your funds will last so you can make smart decisions about where to invest and where to pare back your spend.
But if knowing your cash position is paramount, how do you forecast your cash position in the months and years ahead, and the impact of your investments or revenues on that cash position?
In today’s post, we’ll go over five reasons behind the importance of accurate cash flow forecasting. But first, let’s get on the same page.
A cash flow forecast is an estimate of the money you expect to flow in and out of your company. It includes all your projected income and expenses and usually covers an entire year, although it can also cover a shorter period such as a week or a month.
Preparing a cash flow is a complex process with a lot of moving parts that’s based on 7 fundamental steps:
This is important because it helps you distinguish between the core day-to-day operating activities distinct from investments you’re making—in CAPEX, for example—that you hope will pay off over time and from financing.
Congratulations—your model is ready to use! Analyze your delta at the end of each month, build the habit of reforecasting and keeping an eye on your runway (eg your “oxygen”).
Given how important stable cash flow is for any company (especially for unprofitable SaaS businesses investing to grow), let’s dive into the impact of having an accurate forecast of cash flow.
An accurate cash flow forecast is crucial for understanding the consequences of the key decisions your company makes. It allows them to identify cash balance red flags like a negative balance and react before it’s too late. It also allows you to forecast short-term financing needs and plan when you need further investment.
With an accurate overview of your inflows and outflows, you can take remedial action on problem areas. For example, if certain customers are slow to pay, you can double-down on your collection efforts, or shorten payment terms in your contracts.
Accurate cash flow forecasting also helps answer questions such as:
Accurate cash flow forecasts give you a better overview of your runway at your current burn rate and the steps you need to take to position yourself for success. If you know that you can’t get further investment for another 12 months but your cash will only last 10, you know you have to find ways to reduce burn to extend your runway.
Burn rate also helps you understand when your business needs to start looking at funding options for your next round of investment. You can combine that knowledge with how long it’s historically taken to close an investment round to make sure you don’t run out of cash.
When you accurately forecast cash and give regular updates to your investors/lenders, that increases trust gives them more comfort in the safety of their investment or loan, and can improve the terms you can negotiate.
As we’ve mentioned in the previous section, managing cash burn and knowing when your next investment round will take place is crucial. If you can demonstrate to investors/lenders that you can accurately forecast this, their comfort in your management abilities will go up and they’ll be more likely to invest in your business in the future.
In situations where you have limited cash or your burn rate is higher than expected, accurately forecasting cash allows you to prioritize the order in which creditors are paid. If you do a bad job forecasting cash, that may lead to paying low-priority creditors first. As a result, you can end up in a situation where a mission-critical creditor hasn’t been paid and your funding is cut off.
Having accurate forecasts also helps you prioritize payments to minimize interest while maintaining liquidity. As an example, let’s say you have substantial cash and can repay a loan in advance. Confidence in your cash flow projection and knowing you’ll be covered in the future will give you the confidence to repay the loan early.
An accurate cash flow forecast will show you the impact working capital has on your cash position so you can determine if you should focus on reducing it. Reducing your working capital will also reduce your need for cash so you can carry a lower balance or delay future investment activities.
Projecting cash flow is complex and requires agility, as things can change so quickly for your business. But the more accurate you can make a cash flow projection, the more powerful they become and the more confidence they give you in the decisions you make to help your business thrive.
Ed note: Want to dive deeper into essential FP&A topics? Check out OnPlan’s most popular posts of all time here:
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