Managing Cash Flow – Maximizing Business Performance – Part 2 of 2

Managing The Cash Flow Tightrope

The basis to managing cash flow is to ensure that you measure it – plan for it and prepare.  Cash flow forecasting is an essential management tool, allowing you to understand the peaks and troughs of your business and understanding the effect of seasonal variations, credit policies, and balance sheet transactions.

“The three most important things to measure in a business are customer satisfaction, employee satisfaction and cash flow.” – Jack Welch former CEO of General Electric. Jack Welch is generally acknowledged as one of the all-time great CEOs and we think he’s spot on with this assessment. It’s interesting to note that two of those three are non-financial Key Performance Indicators (KPI’s).

Forecasting and Planning your Cash Flow

It is prudent to maintain a Cash Flow and Profit Plan for at least the next 12 months of operations so that you’ll be able to address these three critical questions:

• How much cash will my business need?

• When will it be needed?

• Where will I get it?

Do you have the cash your business requires or should you apply for financing – this process takes time?  Determine if it’s feasible for a bank or other institution to loan your business money.  Creditors will require certain base equity capital investments before they will provide debt financing.  Will you have excess funds to place into short-term investment, or long-term asset building.

You’ll then be able to structure your business’ policies for working capital management to meet your cash needs, or apply for financing.

Once you have your 12 month forecast you should “roll it over” on a monthly or quarterly basis so that it remains current, otherwise it will be out of date virtually as soon as you have completed it. Remember, what you can measure you can manage.

Step 1: Sales Forecasting

Start the cash flow forecasting process by Sales forecasting. Look at what products and services you are going to sell and estimate the number of units you will sell per item per month.

Decide on the price that the market will allow – based on the value of your product or service to individual categories of clients.  Take into account past sales and profitability of each product line, seasonal effects on sales, your competitors or emerging competitors for each product, and business environmental changes.

Who will your customers be this year?

How many clients will return, and how many will be new clients?

How much will each customer buy?

How many times will they buy from you?

What price should you charge?

What is the market willing to bear?

What are your competitors charging?

This analysis has the added advantage of helping you understand your profitable services/products and customers.  Please consider each product or service
separately in order to get sufficient information to make the most educated
decisions.

If you have any other income generated, other than by sales – include this also.

Step 2: Direct Costs Of Products And Services

The next step is to look at the direct costs of your product/service.  Take the number of units which you have estimated in your sales forecast.  Determine the composition of each unit.  Cost each part of all the units.  Take into account what your suppliers are charging.  Should you consider changing suppliers, or are you happy with the service and prices of your current supplier?  What additional costs do you incur on each product or service before selling it (ie inventory carrying costs).

Step 3: Expense Forecasting

Look at the different categories of expenditure:

Variable Expenses: Operating expenses which vary in direct proportion to sales revenue.

Activity Expenses:  These expenses are essentially variable expenses, but they don’t necessarily vary in direct proportion to sales revenue.  They’re driven by the level of activity that goes on in an organization, which is not always an indication of results achieved.

Fixed Expenses:  Those expenses that are independent (at least in the short term) of the monetary value of sales and the level of activity.  Very few expenses actually fall into this category, but a good example is rent.

As part of your expense forecasting, some of the estimates and assumptions you’ll need to make may include:

Will you be hiring new team members? How will that affect other expenses, like office space and phone charges?

Will you be increasing salaries?

Are you keeping benefits the same, or introducing new ones?

What are your estimated tax payments?

Step 4: Reviewing The Profit

Once you’ve done your revenue and expense forecasting, you need to be sure you’re making enough profit. If not, your choices include one or both of the following:

Increase your sales – or – decrease your costs (but remember: you can’t shrink yourself to success).

Most importantly, aim high and be realistic.  And remember that changes take time and don’t
happen overnight—but they can happen with proper planning and KPI monitoring.

Step 5: Plan Your Cash Flow

Estimate when you’ll be collecting cash. This will be dependant on your level of cash sales and your debt collection policy on credit sales. Estimate when you’ll need to pay cash out. Look at credit terms of suppliers, discounts offered by suppliers, team member payday’s.

Plan for any Balance Sheet transactions, such as equipment purchases or improvements.  Determine what fixed assets or asset improvements you plan to invest in during the next
12 months.  Determine what fixed assets you plan to dispose of during the next 12 months.  Decide on the distributions that will be made to the owners. Account for any capital funding from investors. Finally, see how much more financing you’ll need.

Managing The Cash Flow

Cash flow planning allows you to identify those potential cash crunches, as well as cash opportunities to invest excess cash flow and increase profitability.  Two methods you
can use to manage and increase the cash flow of your business include:

Employ working capital management by managing receivables, payables, and inventory.  This should be your first choice.

Obtain financing or additional capital.  This should be your second choice, as financing and capital sources cost money—interest expense and financing fees for example.  They can reduce
profitability, and most importantly, financing is not a guaranteed source of cash flow.  Banks and other lenders will require your business to meet its lending criteria.

Even Out The Flow

Another area businesses struggle to deal with are the peaks and troughs in the cash flow.  This can cause us to run short of cash in one month and have a large surplus the next.  Potential ways to level out these peaks and troughs are as follows.

Marketing.  If marketing is performed prior to a notoriously bad time of year, you have the
potential to pull the trough upwards.  An example of this would be a gardening business where customers normally spend money when the summer starts, and the weather is more favorable.  Marketing that involves information on activities that should be being performed in the garden for preparation for summer can be started early.  This marketing can include specials and packages to entice the customer to spend early.

Work scheduling.  Encouraging non-urgent customers to wait for goods and services to a
slower time of year can assist not only cash flow, but work flow as well.

Pricing structure.  Increasing prices when there is the largest demand can also assist.  An example, are airlines who increase prices during the most busy periods.  This can
either just increase revenues in the peak months to help you over the troughs, or it will encourage your customers to spend in the trough months.

Measuring Your Performance

Cash Flow forecasts are useless, unless the actual results are monitored regularly.  Failing to
fulfill, or exceeding your assumptions, can affect the long or short-term viability of your plan.  Measure and understand the effects of variations to your plan.  Remember the business environment is constantly changing, and the same thing that works today won’t necessarily work tomorrow.

There is always the opportunity to be better.  If you’re not monitoring your actual results
regularly, you can’t capitalize on that opportunity.

Key Performance Indicators

Key Performance Indicators are critical financial and non-financial measures of activity outcomes that indicate, on their own or in association with other KPIs, how a business or process within a business is performing.

In preparing a cash flow plan and profit plan, you make a variety of estimates and assumptions.  These are examples of KPIs you may want to review regularly to be sure your business is operating according to plan.

For example, in sales forecasting you estimate the number and types of units (i.e., products or services) you anticipate to sell this period.  To get this estimate, you probably determined who your customers would be and how often they’d buy from you.  So one of your KPIs would be the number of customers.  By tracking these in a database, we should have fairly accurate statistics each month.

Another KPI would be how many times they buy from you.  Only by knowing how often they buy from you can you successfully implement a strategy to increase the number of times they buy from you.

Working Capital Management offers several KPIs, including:  Inventory turnover, Receivables turnover, and Payables turnover.

The success of these KPIs will ultimately determine the success of the Critical Success Factors:
Profit and Cash Flow.  You can’t influence profit directly, and influence on cash flow is limited as well.  But you can influence many of the items that drive them – when you input your actual results every month and compare them to your plan for these measures, you’re doing KPI monitoring.

Monthly KPI monitoring will help you proactively identify both emerging problems and opportunities and ensure that you get the most out of your cash flow plan and profit plan.

Some KPIs may need to be monitored more than monthly, while some may need to be monitored less frequently. The frequency of reporting will become quite evident once the KPI is defined, but the majority of KPIs should be monitored at least monthly.

Conclusion – Steps To Developing And Monitoring Your KPI’s

Here are 4 easy steps to help you get started:

1. Determining what needs to be monitored in your business (your KPIs)
2. Input the actuals and comparing them to plan, either monthly or some other frequency
3. Identifying variances to plan
4. Taking corrective action as needed

Each process owner should be responsible for the KPIs related to their process.  Defining KPIs
can seem difficult and requires regular review that the right things are being measured and monitored.

But the rewards are substantial because what you can measure, you can manage and ultimately improve.