Forecast Your Future – Cash In, Cash Out

To take control of your money situation, it’s critical to establish a fundamental understanding of how money flows in and flows out of your company.

Welcome to 8 Steps to Managing Your Money: A Business Owner’s Guide. You’ve landed on Step 1, Forecast Your Future, which­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­ ­­­­­­­­­­has as much to do with sanity as it does strategy. To take control of your money situation, it’s critical to establish a fundamental understanding of how money flows in and flows out of your company. And that’s exactly what we intend to help you do.

Though the common term for this discipline is called cash flow “forecasting,” which you’d think would only help you peer into the financial future of your business, the fact is that cash flow forecasting helps you tune in to what’s happening this very week.

If you’re like most newbie entrepreneurs, you’re probably hearing a voice in the back of your head murmuring something like, “This is going to be dreadful. I hate the numbers.” Welcome to the club. Pretty much everyone feels that way until they learn how empowering knowing your numbers can be.

So try to run that voice out of your head. Being savvy about the math of your business will help you gain vision, creativity, clear options, the ability to make informed plans, and yes, peace of mind. Best of all, reckoning the reality of “the numbers” forces you to be sober about your business, providing balance to one of your greatest and most vital assets for success – your passion.

Now, let’s get to it.

Cash flow forecasting focuses on quantifying exactly how much money is coming in and going out of your business’ checking account each month. Below we start with cash coming in.

Cash In

Cash in = any and all money that you receive in a given month.

Start by listing out all inbound money that you anticipate receiving in the months ahead. This can include sales revenue, bank loans, an equity investment from your rich uncle, your personal financial contributions to the business – any form of money that flows into your business bank account.

Regarding sales revenue, be sure to take into account the timing of payments you expect to receive. For a business based on cash receipts (including credit card payments), this is an easy exercise because there’s virtually no lag time between the product or service you provide and payment you receive. When the transaction is complete, you are paid. End of story.

If your business is the kind that extends payment terms to customers, factor in a lag time of 30 days—sometimes as much as 90 days—before you’re paid. And to be conservative, if your terms state that payment is required in 30 days, you may want to play it safe and assume in your planning that it will actually take 45 days. This way, the variances in your forecast will fall only in the “pleasant surprise” category, not in the “uh oh, I can’t pay the bills this month” category.

During this exercise you might also want to ponder ways you can receive payments from customers more quickly. Can you ask for money up front or at least a portion of the payment? See Step 2: Rationalizing Your Revenue for more on this.

Cash Out

Cash out = any and all money that flows out of your business in a given month.

Once you’ve mapped out your inbound money, it’s time to get a handle on what’s flowing out of your coffers.

Take into consideration all of your expenses on a monthly basis. Include things like employee wages and benefits; supplies; taxes on sales, income and property; interest payments on loans; insurance; rent; cost of goods sold; payments for shiatsu massage (line item, “stress relief”), and any other expense the company will be obligated to pay out in a given month.



Pay The Boss (That’s You)

As the business owner you are probably paid last and as noted early are the first to put money back into the business. How much and when you can take money out of the business depends on whether you have business partners or other stakeholders, such as a bank or investors in the business.

From a money management standpoint, you should plan to pay yourself a ‘market salary’ each month for your role and time spent working in the business each month. It is important you account for your pay, even though you realize you may not draw that amount each month. You can ‘catch up’ in later months if you have the money in the business to do it.

Now for a question: When mapping out cash inflows and outflows, which of the two do you think entrepreneurs most commonly over estimate? Which do they most commonly underestimate? If you don’t know the answer by experience, the you probably know it intuitively. Avoid the trap of creating rosy cash in-cash out assumptions. Otherwise, your planning for the future will be based on high-risk assumptions.

Planning the future

What should start becoming clear is a sense of the comparative inflow of cash versus the outflow of cash. You’ll begin to get a picture of fluctuations in money left in your bank account by drilling down to this level of detail. And the chances of a big, scary surprise will be minimized.

You’ll also probably notice some trends. Do expenses grow as sales grow? Or, are you seeing that your revenue is growing faster in proportion to your expenses. If so, this is a promising sign that your business “scales”—that the profit margin, the difference between what you sell for and what it costs to sell, increases as revenue increases.

On the other hand, you may notice that the profit margin gets thinner over time. This can result from having to add infrastructure like people, expensive technology, commissions, increased rent for expanded facilities, outsourced services, etc. If this is the case, it’s not the end of the day – you just need to be aware of the phenomenon and do whatever you can to counteract it. If your cash flow forecast shows your margins getting too tight over time, you may want to rethink your overall strategy for the business. Do you really want to give all your energy to a business that performs that way?

These scenarios require slight finessing and tweaking of your strategies to get the balance between cash in and cash out working to your advantage. But what if, after plugging in all the cash in/cash out numbers, you notice a bigger problem – the business does not turn profitable any time soon. Obviously, unless you’ve got a lot of startup capital to carry you through a long period of money-losing months, you’re in a predicament. Most likely, you’re going to have to take a totally different approach to how you spend or how you generate income.

One last point on being conservative: in spite of your best efforts to forecast cash flow, unexpected events always seem to creep up on you. That could mean a slowdown in revenues, for example, in which case it’s very important to have a contingency plan in place. This contingency plan would outline the key steps you need to take to cut costs quickly in order to stay afloat. Yes, those cuts will likely be painful, but the ability to act quickly on tough calls as a business owner is crucial.


Forecasting with a Factor

At the earliest stages of a startup—those thrilling days just before and just after hanging the “Open for Business” sign for the first time—it’s easy to get swept away with calculations about how ginormous your business opportunity is or how your company’s valuation is going to inflate to a massive scale. But there’s nothing more important than the most basic stat of your business – money in versus money out.

Jim Chamberlain, a CPA and business coach in Orange County, Calif., says to plan your growth, you have to be conservative. He’s referring to the common mistake that many small-business owners make by underestimating the amount of money they will spend to keep the venture running.

To address this, experienced entrepreneurs often use a “padding” factor in their numbers. Their street wisdom suggests that things will cost more and take longer than projected. That’s when they add in padding on expenses and timelines anywhere from 20% to 30%. So you can modify this factor of time, you can leave it in your spreadsheet as a line item. This keeps all real numbers real. To be sure you’re always erring on the conservative side, you should consider padding your downside, too.

Don’t go getting all scared and depressed about your business as you conduct this downside planning. The fact is, the more you’re ready for any negative turns or circumstances, the more likely you are to avoid them. With the right plans in place, you’ll always be best prepared to respond quickly and effectively and put your business on the best path forward.

Here in Step 1, we’ve tried to simplify the process and make clear the value of creating a cash flow forecast. To truly cash in, you have to understand and take control of cash in and cash out. By becoming intimately familiar with your cash flow forecast, you’ll make consistently smarter decisions about your business, giving you the best chances for success.

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