How can cash flow forecasting help my small business avoid running out of money?

Poor money management is often cited as a major reason that small businesses fail, and the numbers bear it out: the Bureau of Labor Statistics places the number of small businesses that fail in their first year at about 20%; about half survive five years, and only a third make it to ten.

Half the small businesses surveyed–over 300 businesses–ran without a budget in 2020. Numerous industry reports underline why this can be a precarious balancing act; one report found 31% of small businesses had two months or less of cash reserves, with 58% in a range of three to five months. Margins can be thin, debts can be substantial, and unpaid bills can be a major risk for some firms. Even profitable businesses can expose themselves to tight margins with one big purchase or one key downturn.

Overdue Bills

Collecting unpaid invoices should always be a priority. Overdue bills can contribute to running on tight margins, and anything you can do to claw back those payments can help. According to QuickBooks, midsized firms were owed $304,066 on average by late payers, and 81% saw more late payments in 2021. As each day goes by, a dollar in your client’s account is a dollar you can’t do anything with. Your clients have things they want to spend on, and it doesn’t pay you to fund those purchases at your expense. As invoices go unpaid, they keep you from paying your bills and investing in your company. Depending on the volume of late payers you take on, you might require tighter payment terms.

Offering two percent for early payment speeds cash in. But that costs 44.6% annual interest, if offered continuously. So instead of offering a permanent two percent discount, just price invoices two percent higher.

Why keep that cash on hand? Any surplus of cash gives you options to take advantage of. It’s also a major business advantage: that pile of savings can be used to buy in bulk when vendors offer you a discount or stock up on your key inventory to prepare for a pinch. Every receipt and expense, even irregular utility bills, goes into the forecast. So does an accurate prediction of revenue.

Short-term forecasting looks out up to six months. This style of forecasting, also called direct forecasting, uses immediate cash in the business. It tracks outflows for things like supplier payments and when your invoices are due from clients. For a fairly stable business, your forecasts can be highly accurate. Longer-range forecasts look out one to five years, leaning heavily on the income statement, the balance sheet, and the cash flow statement.

A business with a solid forecast tool would understand when to consolidate, expand or slow down. So it’s a little surprising that 70% of surveyed small firms used spreadsheets for business just five years ago. But spreadsheets are very time consuming and error prone. Even if you know Microsoft Excel well, moving to the cloud lets you gain insight with technology like AI and machine learning instead.

Scenario planning in a forecast is an advanced concept that lets you plot out and control different possibilities. Want to see what happens if you hire more people or you lose a client? If you have enough historical data, just plug it in and see what happens. It’s like building an interactive financial model, bringing precision to your plans and your priorities.

Banks have their own portfolio of cash forecasting tools. But if you’ve ever seen banking information, it’s pretty barren. You get a chart of transactions and money transfers, but the “money in/money out” model tells you almost nothing about what’s really going on in a business. In March 2022, a survey found 55% of small business owners using their bank’s cash management tools said the tools stressed them out.

Managing cash flow is much like steering a ship; with no idea where your finances are headed, your future is always an unknown, and it’s dangerous. If you didn’t have a forecast, you might not see where you’re going until you run out of fuel or crash into an iceberg, and as a business, that can be fatal.