Running on Empty

Enhanced forecasting can help firms take action before exhausting their cash

Ever feel on the brink of cash flow exhaustion? You know the signs: an abrupt change in the marketplace, a failed ownership transition, mismanagement or simply the failure to make your sales forecast from month to month. The result is the same in each case: running out of cash.

Getting off course can happen far too quickly if small business owners do not carefully watch how expenses are lining up with revenue. Many continue to operate, even in this down economy, under the false assumption that an annual budget is all they need to manage their business. Unfortunately, by the time revenue falls short and cash flow ebbs, it’s often too late to make adjustments. Once bank covenants are violated and your lender is unwilling to renew your line of credit, many owners have trouble finding a new lender given today’s tighter requirements.

A remedy for cash insufficiency is a rolling quarterly forecast – a 13-week cash flow projection that allows more timely decisions when changing conditions impact revenue. It provides a detailed analysis tied directly into a tight sales forecast and the general ledger to track cash expenses and revenue. Timely variance analysis – examining the difference between projected and actual information – and proactive management are the keys to success.

Since cash is the ultimate performance indicator of good health, this approach reveals the losses before they materialize in your financial statements. Losses can be hiding in inventory that has disappeared, been miscounted or already been shipped, and in receivables counted as good that are really uncollectible.

Although lenders still want to see your annual budget, it is not an especially effective tool for actively managing a small, growing company operating in a dynamic environment. For example, there’s always a certain amount of guesswork in sales projections. But once you’ve committed to an expense structure to support those sales, the annual budget isn’t going to help you reduce those expenses if the sales force isn’t hitting its numbers.

A quarterly forecast encourages accountability by promoting a weekly comparison of forecast to actual results. A good forecast looks at existing and potential customer relationships. It gets down to the customer level for forecasting revenue and points out the strengths and weaknesses of customer relationships. If revenues aren’t materializing, it’s time to ask key questions: Are we losing our market? Is this customer fading? How can we shore up our relationship? When will we get paid?

Someone needs to champion this effort, whether it’s the owner, CFO or controller. The basic steps include:

Collect information. Start by requesting more details from department managers. It’s really about gaining their commitment in terms of what week a sale or expense is going to fall. You can also rely on account history as a basis for weekly forecasting and validation.

Establish structure. Change your accounting reporting periods to a “4-4-5”, with the first and second months of the quarter consisting of four weeks, and the third month with five weeks. This conversion provides equivalent weeks to review and no month will end in a partial week. Both are essential for generating accurate variance analysis. Many companies format projected costs and income into an Excel spreadsheet by account number to match their chart of accounts, or export information from their computer system into Excel. This information can then be linked to supporting spreadsheets to be formatted and customized to your business needs.

Drill down. Ideally, you can drill down to the individual product or service level to forecast what will be sold, delivered and invoiced each week. A separate spreadsheet tab should be created for forecasting sales, operating expenses and collections. This ability to drill down through expenses and income allows you to see the variances and understand why you’re not hitting your numbers.

Reflect. This approach encourages an introspective look at your business. There’s a story behind every variance that may require research. For example, if labor expense is double that necessary to support sales, there’s an inefficiency in your production process you should investigate.

Make decisions. This weekly view offers the ability to respond to changes and make corrections more quickly to avoid cash flow problems. Perhaps your manufacturing crew could be trained to reduce inventory and increase throughput.

A quarterly forecast isn’t for every business. But for those companies with cash flow issues or owners who don’t have the capital level to make many mistakes, it’s a tool to help them better manage their businesses and understand their sales efforts, customers and operations.

Pat Brennan is a partner with the Platinum Group, a Minneapolis-based turnaround management firm. He has 23 years of experience in accounting, financial management operations and has worked with numerous companies to turn around negative cash flow difficulties.

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