“A rising tide floats all boats but it’s only when the tide goes out that we can see who was swimming naked” - Warren Buffett
Everyone knows the lifeblood of any business is to control your cash flow. Without it a business cannot exist. Why then is cash flow, or more correctly the lack of, the number one reason that 49% of businesses fail within 4 years?
Here are three key reasons why SMEs run out of cash and how cash flow forecasting can help you avoid becoming another statistic.
1. Historical Cost Accounting
Traditional accounting is inherently backward looking. By focusing too much on what has happened instead of what will happen means businesses may not be adequately prepared for what the future throws at them. Forecasting (and re-forecasting) cash flow is crucial. Now this often requires businesses to purchase additional software, build their own forecasting spreadsheets or hire grossly overvalued consultants to make forecasts for them. Any way it’s going to cost money time and money.
Skippr provides businesses with a free and easy to use cash flow forecasting tool. The tool syncs directly with cloud based accounting software like Xero so updating forecasts using the latest information is easy. Say goodbye to spreadsheets and expensive software.
2. Accrual Accounting
Many businesses fail to adequately plan for the future by placing too much emphasis on accounting profits (or losses) instead of getting a better understanding of what drives cash flow. Rapid sales growth is awesome. However, if accounts receivable is growing faster than sales, it may indicate a problem with collection (or that your sales team is out of control). Neglecting accounts receivable can be fatal. Receivables often forms the largest balance sheet asset for SMEs and yet basic systems to ensure invoices are paid on time are often lacking.
Forecasting helps businesses understand the difference between future profit and future cash flow. Forecasting is not about estimating the future with 100% accuracy. It’s about getting a better understanding of how much cash you need to meet certain objectives and taking steps to ensure you have enough cash to meet those objectives. In business, if you fail to prepare then you should prepare to fail. Forecasting helps businesses prepare.
It’s easy to let collection on a few invoices slip because businesses don’t want to damage relations with their customer. It’s especially easy to neglect cash flow when business is going well. A good analogy is the boiling frog story.
"If you drop a frog in a pot of boiling water, it will of course frantically try to clamber out. But if you place it gently in a pot of tepid water and turn the heat on low, it will float there quite placidly. As the water gradually heats up, the frog will sink into a tranquil stupor, exactly like one of us in a hot bath, and before long, with a smile on its face, it will unresistingly allow itself to be boiled to death."
Running low on cash is similar to being a frog in cold water. By the time you realise you are in hot water, it’s too late. Running out of cash won’t hurt your business, it will kill it.
Let apps give you the foresight you need to manage cash flow. Check out our blog - Virtual CFO, where we review some apps to automate various financial management responsibilities.