Small businesses tend to be structured in a way that the strategic direction of business is determined by the instincts of the owners. This is fantastic for keeping a business agile but may also lead it into financial difficulty without an independent financial cashflow forecast.
Most business owners I meet make one financial check before making an important business decision, which is check their bank balance. If there is enough money in the account to proceed, then they will.
The problem with this is that your bank account only gives you a snapshot of your liquidity at that point in time, but it fails to give you an indication of what financial position you will be in within the next 12 minutes let alone 12 months.
So, you may have £20,000 over and above what you were expecting in the bank right now, but have you considered why that is the case?
Wasn’t £10,000 related to the sale of a bit of machinery, which you were going to use to put down a deposit on another piece of equipment?
Didn’t you also just receive a £12,000 invoice from a customer for a job that you had to use £8,000 worth of subcontractors, which you still need to pay?
Now you mention it, isn’t it the year end this month and you are due to pay staff bonuses? And of course, the VAT bill is due at the start of next month.
When you factor all these things in, you realise your cash position isn’t as rosy as you thought, and you actually haven’t got the funds to start that new service line or pay out that dividend.
So, this is where forecasting come into decision-making.
This can be as straight forward or as complicated as you want it to be. However, at its most basic level, to accurately forecast your cash balance to a point in the future you need to understand:
- What is my cash balance now?
- Tax in quarterly instalments?
- Do I have any loan or Hire Purchase payments to make? What are the monthly costs or those? Are any of the agreements coming to an end?
- Any staff bonuses or pay rises?
If you can answer those questions with some timings, then you can start to pull together your own short term cashflow forecast.
Things start to get more complicated, the further forward you try to project, as there are more unknowns. However, having a short term cashflow calculation in front you when making important decisions is better than your bank balance.