Time to Act
Charlie Goodrich 
Tracking profitability is essential, but it does not ensure that there will be cash to pay today's bills when they come due.  

In today's edition of Time to Act, I explain the concept of a rolling, 13-week cash flow forecast and offer some suggestion regarding how to use this in your business.

Your comments are always welcome. Just click "reply" to send them to me.
Charlie Goodrich 

Founder and Principal

Goodrich & Associates
May 2013 Vol. 2 No. 5
In this issue...
Managing the Flow of Funds to Creditors in a Liquidation or Sale
Heard on the Street
About Us
Will You Be Out of Cash By Friday? Why You Need a 13-Week, Rolling Cash Flow Forecast
I spent two hours last month on a sales call with one of the founders of a rapidly growing company. In just eight short years, revenue for his business is now pushing $100MM - he's responsible for the company's finances.

Much of the call was spent talking about cash flow and, in particular, cash flow problems. It seems that week to week, there is always a surprise in this area. So I asked if he had a cash flow model, whereupon he spent over an hour walking me through his elaborate budgeting model (as you'll see, they are not the same thing).

The budgeting model tracked every general ledger account, was based on business drivers such as certain customer volumes and so forth, and produced three years of monthly income statements and balance sheets. It was very detailed and works for annual and multi-year projections and planning.

That said, his budgeting model won't help this man figure out if he can make critical vendor payments this week and payroll next week. Because while tracking profitability is essential (something I discussed in a previous newsletter, here), it does not ensure that there is cash to pay today's bills when they come due.

What this prospective client needs is a rolling, 13-week cash flow forecast.

When you forecast cash flow weekly you reduce the likelihood of problems and surprises. As a result of this work, you can see upcoming cash gaps and surpluses and make adjustments as needed.

For example, if cash will be needed for payroll or sales tax later in the week, you know not to pay today's vendor. For companies with credit lines based on a formula tied to working capital (often called the borrowing base), predictable changes in working capital lead to predictable borrowing amounts - unless you don't take the time to predict or forecast.

So how does one forecast cash flow? Follow these six steps to get started...
  1. Begin with cash in the bank, based on current accounting records and up-to-date bank reconciliations. Then layer in actual account receivable balances, actual payables and actual inventory.
  1. Forecast sales weekly. Start with orders on hand, near term production and inventory statistics, etc. Further out in time, switch to trends. Increase receivables by the amount of sales; decrease inventories by the amount sold. Then replenish the inventories with purchases of materials, finishing work in process and so forth, depending on what is relevant for your business. Of course, purchases increase payables. Sometimes it is worth the effort to forecast sales by major customer or by product line.
  1. Forecast cash receipts. Based on customer payment trends, start by forecasting when major customers are expected to pay open invoices. All other customers should be lumped together. Allow for traditional deductions for cash discounts, other credits, etc. Next lay in expected payments on the "forecasted" sales from the prior step. Of course, decrease receivables to reflect the payments.
  1. Factor in cash disbursements. Start with actual payables and spread them by week when they are due and by major category, such as raw materials, purchased goods, utilities, etc. Then add "forecasted" payables for inventory that was "purchased in the model to support sales."
  1. Add payroll based on actual and projected staffing levels by payroll due date. When staffing varies by sales or production volume, model that too. Also add any other fixed and predictable payments such as leases, maintenance contracts and so forth. There are likely other expense categories that are unique to your business, so include these as well.
  1. Finally, forecast borrowing, subject to either credit line dollar limits, or borrowing base formulas that are based on the forecast receivables and inventory.
There you have it, a weekly cash flow model. Yes, it can be complicated and yes, such a model does require an understanding of the financial linkages of your business. But as described above, it's worth the effort.

A few additional things to keep in mind as you pull your forecast together:
  • Note that the forecast begins with actual cash, receivables, payables and inventory. Make sure these accounts are reconciled monthly and proper controls are in place including physical counts of inventories. After all, if the records are wrong and actual isn't actual, the model's projections will be wrong too.
  • Avoid decisions that generate immediate cash but are fundamentally unprofitable. For example, sales at a loss may immediately increase receivables and cash availability from a lender, but unprofitable business drains cash in the long run.
  • Make sure to analyze variances between forecast and actual. That's how you'll improve your model over time.
  • Never lose sight of the fact that cash flow is not the same as profitability.
  • Larger companies may need to forecast cash flow more abstractly, but the concepts are the same. Cash-rich companies with little or no debt will benefit from cash flow forecasting through better cash investing.
Liquidity is essential for any business and forecasting cash flow on a weekly basis is a vital tool towards that end. 

A robust, rolling, 13-week cash flow model will help you stay on top of your obligations and opportunities, and help make certain that when payroll and taxes are due, there's always enough cash in the bank.

Heard on the Street
There has been a lot of discussion over the last several years on inflation and how to measure it.  Which price index best measures inflation is a topic of much debate.

What we often take for granted (and don't discuss), however, is the importance of the plain price of a good or service in the economy and what happens when prices are arbitrarily set by the government.

In his recent newsletter, Erin A. Yetter of the Federal Reserve Bank of St. Louis offers a crisp refresher on the importance of price.

About Us
Goodrich & Associates is a management consulting firm. We specialize in helping our business clients solve urgent financial problems. Our Founder and Principal, Charlie Goodrich, holds an MBA in Finance from the University of Chicago and a Bachelor's Degree in Economics from the University of Virginia, and has over 30 years experience in this area.

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