With all the uncertainty surrounding the current economy, it is more important than ever to understand your cash flow needs. You may be utilizing a monthly forecast, but it is important to now use a weekly forecast as events are changing rapidly. Why 13 weeks? While 13 weeks is one quarter, it is also long enough to make strategic decisions while being short enough to provide higher accuracy. The forecast isn’t going to be an exact measure, but rather a tool to give you insight into where potential cash shortfalls may occur.
To get started, you need to have an understanding of your current situation. Just because you have sales and net income, it doesn’t mean you have cash. This should be done by evaluating the current cash position, working capital needs, and cost structure. The following ratios and analysis will be useful in understanding your current business situation:
- Current ratio
- Working capital
- Understanding fixed vs. variable expenses
- Breakeven analysis
- Cash conversion cycle
With a strong handle on the current situation, you can build out a cash flow forecast using some of the assumptions from the ratios and analysis above. Develop the weekly forecasted revenue based on your current backlog and understanding of the sales cycle. From there, you can plot out when collections are likely to occur based on history, adjusted for current conditions.
The next step would be to forecast out the expenses for the next 13 weeks. Depending on your needs, this can be done at a high level using historical ratios or it can be very detailed looking at when payments are actually due. If going the detailed route, identify the recurring weekly or monthly expenses that do not run through accounts payable (payroll, loan payments, etc.). After those are determined, you can use the current accounts payable ledger and historical averages to plot out the remainder of expenses.
Once your cash flow forecast is complete, you’ll have increased visibility to assess the current situation. Are there any weeks where it looks like there will be a cash shortfall? If so, what is the plan to address that? Can we tweak the dials to put ourselves in a better cash position by:
- Reducing days sales in accounts receivable
- Extending repayment days in accounts payable
- Negotiating better terms with suppliers on purchases
- Reducing operating expenses
- Delaying capital purchases
- Sell equipment that is no longer needed
- Run specials on any slow-moving inventory to convert it to cash
- Have owners contribute additional equity or loans to the company
The forecast should be compared to actual results so you can adjust your rolling forecast as necessary. It might be too soon to see the full impact of COVID-19, but utilizing a cash flow forecast will help you be prepared and respond accordingly to any financial challenges that lie ahead. We’ll discuss this and more in our upcoming webinar ‘Developing a 13 Week Cash Flow Forecast.’