MABC Blog

Richard Branson famously said, “Never take your eyes off the cash flow because it is the life blood of business”.  This is great advice from an accomplished entrepreneur. Unfortunately, many business owners do heed it. Many companies do not regularly forecast cash flows. While it may not seem important if everything is going well, there are a multitude of benefits from this simple exercise that can help your company regardless of your overall business health. Not only does it give owners a better understanding of their company’s liquidity over the short to medium term, but it has a host of other benefits as well. These include reduced costs, increased efficiencies, better coordination within the organization, and several others.

Why Create a Weekly Forecast

Many owners are skeptical of creating cash flow forecasts. They think, “We aren’t in trouble and don’t foresee any issues”. Well, did you foresee Covid-19? Did you know exactly when the 2008 financial crisis was going to happen? There is always uncertainty in the future. If you wait until you are in a distressed situation to create a cash flow forecast, it may already be too late for you to affect it. Furthermore, your forecast will likely be hastily thrown together, and will not include any of the wisdom or insights into your business gained from long history of forecasting, comparing, and revising your cash flow estimates. No matter how much liquidity you have now, there are always limits on liquidity. It is wise to know these limits and keep an eye on them.

Many owners also think, “We can’t afford it” or “We do not have the time, staff or resources to put a cash flow forecast together”. The truth is you cannot afford not to forecast. The understanding gained from forecasting your cash flows does not just help prevent a liquidity crunch, it can lead to greater integration across the business, lower costs, and more effective deployment of capital.

Lastly, a lot of owners ask why they have to do it weekly? Why not monthly? Monthly forecasts are fine for looking for overall trends in cash position but the sampling rate is too low. Monthly forecasts will not catch drops in cash mid-month, which is especially important if you know you have a significant expense due mid-month (ex. Payroll). A more granular, or higher frequency, forecast will capture this kind of fluctuation. Daily forecasts would be great, but revising forecasts daily is just too onerous. Weekly forecasts achieve the right balance.

What are the Benefits of a Weekly Forecast

As I mentioned before, the main reason is to gain a deeper understanding of your company’s liquidity over the short to medium term. A cash flow forecast will give you an early warning of an impending cash crunch and allow you time to react. However, an increased understanding of your liquidity is not the only benefit of weekly cash flow forecasting. There are a number of others.

It instills a “Cash Flow” is reality mindset

Accrual accounting and GAAP can conceal the actual changes in the cash balance of a business (as I discussed in my Financial Statement Fundamentals post). This is especially true for seasonal businesses, business with large, deferred revenues, or business using various revenue recognition methods that do not align with cash inflows. Focusing on the actual cash flows can uncover near-term issues quickly and allow you time to react. Furthermore, focusing strictly on the cash flow forces discipline.

It enhances your understanding of the cash required for growth

Growth often constrains cash flow because you are required to outlay cash to increase your inventory before you can sell it and collect cash. It is possible to grow yourself into bankruptcy. Regular forecasting helps you to understand, anticipate, and plan for these cash constraints, and obtain adequate financing when required.

It enhances Your Understanding of your External Business Relationships

Focusing on cash inflows and outflows forces you to examine when you actually receive cash from customers and when payments are actually due to suppliers. This helps you identify which customers always pay on time, or even early, and which ones usually need a little reminder.

NOTE: When you reach out to them to remind them of their upcoming payment, or to check in on why you have not received it yet, take advantage of the call as an opportunity to generate more business (assuming you want to keep doing business with them). This obviously depends on your relationship with your customer (or contact there) and your industry. I have successfully used this technique in the past in the construction industry when speaking to project managers. 

On the supplier side, one advantage of forecasting is that it requires you to review the payment terms of your suppliers. In general, you don’t want to pay suppliers earlier than you have to. If they do not expect payment for 30 days and don’t offer discounts for paying early, then just pay them at 30 days. On the flip side, some suppliers may offer discounts for early payment. If your forecast shows you’ll have enough cash, you should normally take the discount. In our earlier article on managing working capital I cover the costs of not taking a discount – you’d be surprised. As you review your suppliers, also consider which (if any) you have a good enough relationship to maybe stretch the payment terms in a pinch.

It enhances your understanding of your internal business relationships

Accurate forecasting requires communication between departments and individuals across the organization. If you want accurate estimates, you must talk to accounts payable, accounts receivable, purchasing, sales, HR, etc. and incorporate their insights into your model. Repeating this practice each week allows you to understand their operating patterns and cycles and can give you insights into your business.

It improves your use of cash

More accurate forecasting and management of your cash position means less frequent borrowing, which reduces your interest expense. Knowing how much cash you need on hand to cover expenses allows for better use of excess cash. Instead of sitting in a bank account earning no interest, you can put the excess cash to work. This can include further investment in growth opportunities, debt reduction, increased distributions to owners, etc.

How to Create a Weekly Forecast

Now that we’ve seen that weekly cash flow forecasting is essential for all businesses, how do you go about creating one?

First you need to decide how far out your forecast will extend. You must project far enough out to give yourself time to react to issues your forecast uncovers. However, the further out your forecast extends, the more effort it takes to update each week, and the more speculative your numbers become. Try to strike a balance.  Within one month most firms can use their actual accounts receivable and accounts payable aging reports to create their forecast. However, past one-month, most companies must rely on estimated future sales and expenses, which are less accurate. Again, this varies between companies and industries. 13 weeks in advance (the number of weeks in one quarter) is the industry standard.

Next, you’ll want to create a spreadsheet. Across the top create columns for the weeks you want to include in your forecast. I also recommend including the last four to six weeks of actual historical numbers for reference. Along the left-hand side, create two sections, one for cash receipts and one for cash disbursements. See the example below.

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Then fill in the table. Remember that you need to record when cash actually hits your bank account for cash receipts and when the cash actually leaves your bank account for cash disbursements.

NOTE: One common point of confusion, when you pay an expense with your company credit card, the cash has not left your company yet. It leaves your company when you pay your credit card off. Make sure to account for this nuance in your forecast.

When completing this exercise, remember, it is a cash flow forecast so do not include non-cash items in your estimates. You have to break the accrual and GAAP reporting mindset. Don’t think about revenue, think about cash receipts, especially if you are in a business that takes payment upfront and recognizes revenue over several months, or if you use various revenue recognition over time methods. Don’t think about Cost of Goods sold, think about the purchase of inventory. Leave out depreciation, monthly journal entries reducing prepaid expenses (ex. Prepaid insurance with monthly entries made), goodwill impairment, etc. We are just focusing on cash. Cash moving in, and cash moving out.

When you are finished, subtract the cash outflows from the cash inflows. The result is your change in cash for the week. Finally, add two additional lines at the bottom of the excel file: one for beginning cash balance, and one for ending cash balance which is simply the beginning balance plus the forecasted change in cash.

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If you are showing a deficit consider ways to increase cash receipts, delay or decrease cash disbursements, or figure out how to gain access to additional funds.

NOTE: Quick point about treasury management. If you need additional funds in one account, always draw from the least expensive funding option. If you need cash in your business checking account and have to draw money from a business savings accounts paying 0.25% interest and a money market account paying 0.40%, take the money from the 0.25% interest account since you are foregoing less interest income. If you must choose between a line of credit that charges 5.25% and drawing from a savings account that pays 0.25% interest, draw money from the savings account.

Tips & Tricks

Like anything else, cash flow forecasting takes practice. Your accuracy should increase as you continue week after week and become more familiar with the nuances of your firm. To help get you started, here are some tips and tricks I’ve found useful:

• Sort your expenses from largest to smallest. According to the 80/20 rule, roughly 80% of your cash outflows probably come from 20% of your payables (or vendors). These are the large items you will want to spend the most effort trying to accurately estimate because they can throw your whole estimate off if you get their timing wrong. In almost every company this includes payroll as one of the top items. Many companies also have inventory purchases up here. By the time you have listed these top 20% of vendors it is usually ok to group the smaller remaining outflows into a few line items and spread them across the forecast. It isn’t really worth spending as much time trying to pinpoint when you have to pay a $100 expense as it is for a $100,000 expense. You can always make it more detailed in the future if you need to.
• • Some companies also find it helpful to sort by critical and non-critical vendors or to do this instead of sorting by largest to smallest. I find the critical vendors are often the same as the vendors in the top 20%. I usually recommend sorting by size and then indicating the critical vendors if you wish to either by color coding, or some other method.
  • Depending on your customer diversification and sales structure, it might also be helpful to breakdown your cash inflows in a similar manner. Determining exactly when you will receive payment for invoices can be challenging. Be realistic with your forecasts. Don’t just assume every customer will pay within your payment terms.
• Create a feedback mechanism so you can learn from your mistakes. Save a copy of your forecasts, and then compare it to the actual results when you update your forecasts. Note differences between the two, dig into things for clarification if needed, and write down notes. Often you will realize patterns, such as certain customers always pay late or payroll taxes are higher in the beginning of the year before the wage caps are reached. You may also identify costs you forgot to account for (ex. Property taxes paid once per year) and you will gain a better understanding of how things like holidays affect the timing of expenses. Maintain this practice even after you feel like you have a solid handle on things. In business, as in life, change is the only constant.
• • It can be helpful to create a calendar to go with your notes so you don’t forget those once-per-year or once-per-quarter expenses.
• Develop a network of people in other departments you check in with for information that could affect the forecast and make a habit of doing so weekly. Not only will this improve your forecasts, you’ll be surprised by the other benefits of this increased, interdepartmental communication.
• Update your forecast to incorporate management’s response to it. If you are forecasting a cash crunch and management decides to delay some expenses or draw on the line of credit, update your forecast accordingly. This may result in two versions, the initial, and the one incorporating management’s response. Save the second version for future comparison and forecasting.
• Follow through on the response to the forecast. If management decides to delay some expenses, make sure to tell that to whoever normally makes those purchases. Otherwise they will carry on with business as usual.
• Be sure to account for all the locations you have cash. If you have multiple bank accounts, or a PayPal and/or a Stripe account with a balance, include those in your cash balances.
• Garbage in, Garbage out. (G.I.G.O.) I’ve said it in every post I have related to financial modeling and analysis. If your information is junk, your forecasts will be too. Make sure you have accurate accounting records which include all revenues, expenses, and relevant transactions.

Over the last few years, there has been an increased effort to use A.I. and automation to help reduce the burden of weekly forecasting. While I am all in favor of leveraging technology to reduce workload, I am always a little leery of any automated forecasting programs. In my experience they analyze previous data looking for patterns to generate a forecast for the future. This is fine for identifying trends, and it can shed some light on patterns or cycles in your business. However, it is a poor substitute for your foresight and does not replace a forecast based on input from various departments across your business. You should not drive a car by looking only in the rearview mirror, nor should you create a forecast by looking only at historical information. Always review automated forecasts and incorporate your knowledge and experience into them.

Lastly, the most important tip I have is this: just start. That is the most important piece of advice. Even if it is just with a simple 30-day forecast. As you continue to build the habit, you can add more details, and extend your forecast. But the most important step is to just start.

Conclusion

Growing your business without careful cash management can create cash flow shortages, and in severe cases, bankrupt your company. Conversely, intelligent management of cash gives you an edge for daily operations, handling crises, and growing your business to new heights. Cash flow forecasting is essential to sound cash management. It can give you new insights into your business, give you more time to react to crises, and can lead to more efficiencies and reduced costs. Once you’ve gotten into the habit of weekly forecasting and see the benefits for yourself, you wonder why you didn’t start sooner.

About the Author:

Jon Augelli is a licensed Professional Engineer, Certified Management Accountant, Certified Financial Modeling and Valuation Analyst, and is the founder of Augelli Consulting, LLC. He has a passion for helping business owners achieve their dreams by growing their businesses and preserving their legacy. He does this by offering Fractional CFO and Exit Planning Services to small to mid-sized business owners across Southern Wisconsin. He has advised companies in a variety of fields including engineering, legal, healthcare, fitness, and e-commerce, and has navigated multiple business ownership transitions. For questions regarding topics discussed or CFO & Exit Planning services contact him at: jaugelli@augelliconsulting.com or 608-352-3332

GUEST BLOG POST: We know a lot about small business here at Rescue Desk, but there are some topics that we quickly defer to an expert. Since we work with a ton of number-loving businesses, we have lots of folks to turn to when accounting questions pop up. Thanks to our long-time friend Kari Apel — CEO and President of Apel Associates, Inc — for sharing her wisdom and penning this post on how to handle business Website costs when it comes to tax time.

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The business use of websites is widespread. But surprisingly, the IRS hasn’t yet issued formal guidance on when Internet website costs can be deducted.

Fortunately, established rules that generally apply to the deductibility of business costs, and IRS guidance that applies to software costs, provide business taxpayers launching a website with some guidance as to the proper treatment of the costs.

Hardware or software?

Let’s start with the hardware you may need to operate a website. The costs involved fall under the standard rules for depreciable equipment. Specifically, once these assets are up and running, you can deduct 100% of the cost in the first year they’re placed in service (before 2023). This favorable treatment is allowed under the 100% first-year bonus depreciation break.

In later years, you can probably deduct 100% of these costs in the year the assets are placed in service under the Section 179 first-year depreciation deduction privilege. However, Sec. 179 deductions are subject to several limitations.

For tax years beginning in 2020, the maximum Sec. 179 deduction is $1.04 million, subject to a phaseout rule. Under the rule, the deduction is phased out if more than a specified amount of qualified property is placed in service during the year. The threshold amount for 2020 is $2.59 million.

There’s also a taxable income limit. Under it, your Sec. 179 deduction can’t exceed your business taxable income. In other words, Sec. 179 deductions can’t create or increase an overall tax loss. However, any Sec. 179 deduction amount that you can’t immediately deduct is carried forward and can be deducted in later years (to the extent permitted by the applicable limits).

Similar rules apply to purchased off-the-shelf software. However, software license fees are treated differently from purchased software costs for tax purposes. Payments for leased or licensed software used for your website are currently deductible as ordinary and necessary business expenses.

Was the software developed internally?

An alternative position is that your software development costs represent currently deductible research and development costs under the tax code. To qualify for this treatment, the costs must be paid or incurred by December 31, 2022.

A more conservative approach would be to capitalize the costs of internally developed software. Then you would depreciate them over 36 months.

If your website is primarily for advertising, you can also currently deduct internal website software development costs as ordinary and necessary business expenses.

Are you paying a third party?

Some companies hire third parties to set up and run their websites. In general, payments to third parties are currently deductible as ordinary and necessary business expenses.

What about before business begins?

Start-up expenses can include website development costs. Up to $5,000 of otherwise deductible expenses that are incurred before your business commences can generally be deducted in the year business commences. However, if your start-up expenses exceed $50,000, the $5,000 current deduction limit starts to be chipped away. Above this amount, you must capitalize some, or all, of your start-up expenses and amortize them over 60 months, starting with the month that business commences.

Need Help?

An experienced accountant can determine the appropriate treatment of website costs for federal income tax purposes. Rely on an expert to help you navigate the proper deductions and expenses at tax time.

I talk about the value of time quite a bit with colleagues and clients. We talk about what’s eating away the hours, the benefits of delegating, how it works to have a “virtual” team, and the goals we are all trying to achieve.

Then we talk numbers.

I have this handy little chart I’ve used for years. It’s admittedly very elementary, but it’s effective at showing where you’re leaving money on the table by not getting the support you need. This is especially easy to determine if we’re working with billable-hour business models.

Let’s say your billable time is worth $100 an hour (which I’m only using to keep the math simple … I can practically guarantee your billable time is worth a lot more) and you spend 4 hours a week on non-revenue-generating tasks. You’re basically giving up potentially $400 a week in billable hours… or $20,800 a year!

$100/hour
x 4 hours/week
$400 per week

Otherwise looked at like:

$400 per week
x 52 weeks/year
$20,800/year

You’ll never bill for those hours because, unfortunately, nobody will ever pay you for those tasks.

Now…

Say you outsourced some of those tasks to a service provider who specializes in business support – a bookkeeper, a virtual assistant, a copywriter, a Website expert, a virtual receptionist, etc. You pay that specialist $50 an hour to tackle those 4 hours of non-revenue-generating tasks every week (or roughly 16 hours every month).

At the end of the month, they will send you an invoice for $800.

$50/hour fee
X 4 hours/week
X 4 weeks/month
$800/month

If your time is worth $100 an hour, and you just gained back potentially 16 hours of billable time in a month, you’ve just earned a minimum of $800 in potential revenue after paying for some much-needed support.

$1600 in potential revenue
– $800 fee for services
$800 in potential revenue

That $800 per month … or almost $10,000 a year …. will remain out of reach until you have support because you’ll continue doing it yourself. Nobody will ever pay you for that time or those tasks.

As I mentioned, I used these numbers to keep the math easy. Now do the math using what your billable time is really worth. $150/hour? $200/hour? $400/hour?

If your typical billable hour is $150/hour, for example, and you hire an expert for the same $50 an hour to do those 4 hours worth of work, you potentially opened up more than $20,000 in annual revenue.

Now consider the work you do that’s arguably worth even MORE than your typical billable hour … strategic planning, business development, product or service innovation, etc.

The bottom line is the cost of your support team remains the same, but your potential revenue increases significantly.

Business owners need to spend their time growing their business, generating revenue, strategizing, innovating, and exceeding customers’ expectations. They don’t need to spend time managing marketing touch points, or updating their Websites, or researching vendors, or maintaining their social media, or reconciling their books, or answering their phones, or any number of other process-driven, systems-based tasks.

Invest in growing your team and stop bumping your head against the ceiling of capacity.

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Rachel Rasmussen is the owner of Rescue Desk Virtual Assistant Services. Since 2008, and she and her team have been an "executive assistant for hire," helping overworked business owners make their to-do lists more manageable. Read more of Rachel's musings on business, life as an entrepreneur, and making the most of all of it on the firm's blog.

As business owners, we’re often up against challenges we aren’t sure how to figure out.  So, what do we do?

We find an expert and ask.

Many of us have partnered with experienced consultants, business coaches and executive advisors, and it’s often one of the best investments we can make in our companies ... and ourselves.

Without the expert guidance of an experienced business consultant or coach, we might never build our perfectly-suited teams. We may struggle to learn truly effective finance-based decision making. We might never be pushed to make meaningful stretch goals. It might take us longer than we’d like to understand how to pull ourselves out of the day-to-day operations when our long-term strategy needs some attention.

It’s like the old adage: “Just because you can, doesn’t mean you should.” It’s the same premise working with an expert business consultant. Nobody doubts that you can teach yourself how to reach the next level of success. But, if someone has already “been there, done that” and has the training and expertise to teach others, wouldn’t it be more efficient and cost-effective to simply ask them?

Finding a consultant, coach or advisor is easy. Finding the right coach takes some effort. You need to know what you don’t know, you need to be open to feedback and guidance, and you need to have the self-awareness to understand where the gaps are in your learning.

Do you need tactical guidance in a very specific area? Do you need to evolve your role to match your succession plans? Do you need a sounding board and someone to challenge you to think bigger and ask better questions? Do you need help evaluating growth strategies that balance growing customer demand without diluting service? Do you need someone who can expertly advise both you AND your leadership team?

Making the right investment in the right consultant can pay back exponentially in time, resources, revenue, and most importantly, knowledge. It’s difficult to go wrong in partnering with an advisor who can help you push your organization to the next level.

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Madison Area Business Consultants, Inc. is a professional association of business consultants located in and around Madison, Wisconsin. Our members specialize in providing an objective point of view to help you and your organization spot and analyze problems you might not be able to see or recognize.

Here's a great LinkedIn article by Trey Fischer of KatLanTat Services.  Click the link below for more information.

https://www.linkedin.com/posts/tim-fischer-1877447_contactcenter-contactcenters-contactcentersolutions-activity-6696806540713713664-Nioy

Check out this great Focus Matrix handout from Tina Hallis Ph.D!