IMPORTANCE OF CASH FLOW PROJECTIONS & CASH FLOW REVIEW

Prepared by: Paul Botha (Managing Director at MMS Entrepreneurial Services)   During a recent site visit and review of current systems at a potential new client I noted that one of the main deliverables required by the client is the set-up of cash flow projection and the regular review thereof. During my preparation of our proposal to the client the following true story came to mind.

There was a business program on one of the TV channels. The presenter is a well-known financial advisor and regularly provides commentary on various platforms regarding all issues of economics and finances. In these programs, he each week interviewed a successful entrepreneur and they told their unique story, including all their failures and successes. In one of the programs the entrepreneur told a story that is relevant to this topic. He and his brother used to work for a large retailer. During this time, he remembered that they both had to count inventory at the retailer at the end of every single day they worked there. They used to hate doing this and constantly remarked to each other that one day when they own their own store they will not do this. Thereafter they did get the opportunity to own a shop of their own in the retail business. The first shop opened and the sales was good. They even opened another shop. Sales in the second shop was also very good. They stuck to their decision not to regularly count the inventory at the shop. Both shops were quickly operating at a loss and although sales were good each month, the losses just continued. The long and the short of the story is that in a very short time of opening and operating both these retail stores they went bankrupt, even with good sales/turnover each month! His advice on the program is to always stick to the basic principles of business. Understand your business needs, the difference between profit and cash flow and the importance of cash for your business. Yes, they learned from their mistakes in the first two businesses and they started again and they now own a successful chain of retail stores.

As the saying goes “Revenue is vanity, profit is sanity and cash is king”. Do not underestimate the importance of cash flow projections and the regular review thereof for your entity. The lack of cash is one of the biggest reasons SME’s fail. The correct set-up of this with continued and regular analysis thereof will ensure that you give your entity the best possible chance of making a profit and ensuring that there are enough cash in the entity to operate efficiently. The following basic example will demonstrate that it is possible for an entity to make a profit but not have enough cash to operate the entity:

Example:

Balance sheet of Cash Flow Ltd at 28 February 2017

Assets

In this basic example the entity purchased inventory on credit, made some sales at a profit, but does not have enough cash to settle its liabilities. The cash is tied up in debtors and inventory. This basic example illustrates my point of the importance of cash flow projections and the regular review thereof for your entity.

A basic 12 month rolling cash flow forecast and regular analysis thereof can assist you with the following:

1. Identify periods in the next 12 months where the entity will have a cash shortage. If you can identify the cash shortage upfront, you and your accountant can set-up the required action plan to avoid the cash shortage or manage it with the tools available such as bank overdrafts, loans, appropriate debtor & inventory control procedures.
2. Similarly, you can also identify periods where there is excess cash and accordingly plan what to do with this – use for expansion of the business, save in a fund as an emergency cash reserve.
3. Identity when payments need to be made to your suppliers. Making the correct payments on time to your suppliers is crucial for your continued professional relationships with your suppliers.
4. Identify cash tied up in working capital such as inventory and or debtors.
   1. Inventory
      1. This can be due to slow moving or obsolete inventory or the sales team not performing in the sales department.
   2. Debtors
      1. This can be due to your collection department not following company policy when goods/services are sold to customers on credit;
      2. Or a lack in follow up procedures to collect the money from the debtors.
5. Identify expenditure that is not part of your original budget.
6. It is an essential tool for you as the business owner to give you a summary view of all your cash inflows and cash outflows.

Here are also a few tips you can use to immediately improve the cash flow of your entity:

1. Request payment upfront from your customers by way of a deposit or percentage of the final invoice before you commence the work. The final payment can be made on completion of the work or as arranged between yourself and the customer.
2. If you get recurring payments from the same clients, set-up an “automatic payment service” with one of your financial service providers. This will ensure the correct amount is automatically paid from your customers’ bank account to your entity’s bank account.
3. Discuss credit terms with your suppliers that will suit your business and ensure you have enough time to settle all accounts with them.
4. Review all the accounts of customers with long outstanding invoices/balances. Discuss this individually with each customer and understand the reason why they have not paid you. The goal is to find a solution with your customer to pay you, thus any solution agreed between you and the customer for payment will be better than not receiving any cash at all.

The cloud accounting systems we are using enables real time set-up and review of cash flow projections for our clients. Contact us to set-up a consultation to assist you with the proper implementation of a cash flow projection specially tailored for your entity.

Call our Johannesburg office on 011 672 0020 or Cape Town office on 021 045 0550 for more information or if you need any assistance.

You can also email paul@mmsgroup.co.za

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice.  Errors and omissions excepted (E&OE)