Side note: I’m playing around with AI for concept images. It’s been a bit amusing to see what images I get as a response. It took me a half-dozen attempts to get an image of zoo animals sitting around a conference room table. I ended up opting for a group of actual humans for the featured image, but here’s what I got when I asked for zoo animals:
Now back to the actual subject.
I’ve observed that a lot of business owners rarely look at their Profit and Loss (P&L) statements unless one of three things is happening: the owner is trying to get a loan from the bank, a prospective buyer is evaluating the company for acquisition, or the business has run into an unexpected cash crunch. In most cases, the owner thought the company was doing better and doesn’t understand where the money went. I’ve also had several business owners ask me what they are supposed to be doing with their monthly P&Ls.
If you find yourself glossing over your P&L and feeling disconnected from the numbers on the page, there’s a good reason: P&L statements (and balance sheets for that matter) are designed for tax accountants, not business owners. They don’t generally provide much in the way of actionable insights for running your business. A P&L is the rearview mirror of your business. The P&L shows you where you’ve been but doesn’t tell you where you’re going. Plus, you can’t do anything about the past.
P&Ls Don’t Reflect Cash Flow
There’s another issue with P&L reports that often confuses business owners; they are not a reflection of true cash flow. For instance, if you show a net income of $50,000 over the course of a year, one might expect to see a bank balance December 31st that is $50,000 higher than the bank balance on January 1st. Not so. There are a handful of different items that do not show up on the P&L report, such as owner distributions, principal portion of loan payments, and capitalized equipment purchases. Conversely, there are “non-cash expenses” (typically amortization and depreciation). Your CPA might also make adjustments for tax purposes that will affect your net income, for which no actual money moved.
The Cash Flow Forecast
What every business owner really needs is more like a financial GPS to show you the road ahead. That’s where cash flow forecasting comes in. A cash flow forecast provides a clear picture of where your company will be in 3 to 6 months if you continue on your current trajectory. Here’s a simple theoretical example below.
Early Warning System
Cash flow forecasting helps you identify potential cash shortfalls well in advance. This foresight gives you time to take corrective action while you still have multiple options available, rather than scrambling for solutions in a crisis. In the example above, the company runs out of cash by the end of month four. The shortfall is relatively small, but still might give leadership pause to consider what needs to be done in the meantime. Do we need to ramp up efforts to collect on past due invoices? Are costs out of line? Do we just need to close more business? Are we looking at inflated cost of goods estimates?
Informed Decision Making
Planning a major financial commitment, such as moving to a new office, hiring additional staff, or investing in equipment? A cash flow forecast allows you to quickly assess how these decisions will impact your financial health.
Setting Realistic Goals
By projecting your future cash position, you can determine what your sales targets need to be and how quickly you need to collect payments to maintain healthy cash flow.
Focused Work Culture
With a clear view of your financial future, you can more easily prioritize tasks and direct your team’s focus where the effort is most immediately needed. A cash flow forecast also provides a layer of protection against shiny object syndrome.
Creating A Cash Flow Forecast
Creating a cash flow forecast doesn’t have to be complicated. Start by projecting your expected income and expenses for the next 3 to 6 months. I believe in erring on the side of pessimism. Then, update your cash flow forecast monthly or as substantial new information becomes available. There are apps you can use for cash flow forecasting, but a good old fashioned spreadsheet will suffice. I have trained several bookkeepers to prepare cash flow forecasts; it’s not rocket science.
The real value of a cash flow forecast is the ability to focus your team. When you have a clear and objective view of where your business is headed, you also know exactly where your sales goals need to be and where you need to trim the fat. You know how soon you need to get paid. You have a better way to assess which jobs or clients are worth taking on. Decision-making feels less like guesswork or a magic 8 ball.
If the above sounds like something you need, but you don’t know where to start, grab a time on my calendar and let’s talk.
