Chris Cutrara is an industry “fixer”. He has over 17 years of experience, working extensively with companies going through organizational change. He has a keen ability to quickly identify problem areas and implement new systems to create value for his clients. His first question when evaluating small to lower middle-market companies…..how is your cash flow looking?
Did you know that while cash flow is often a company’s biggest pain point, it can be remedied quickly with 3 easy steps – (1) weekly review of cash balances and activity, (2) sales, accounts receivable and payable forecasting and (3) a consistent weekly projection.
The most urgent concern for many clients is cash flow. We are constantly asked if “best practices” exist for cash flow management. The answer to this question is always a firm yes with many shades of grey, depending on company industry, seasonality and working capital management.
So how well is cash flow being managed? Well, sometimes that answer isn’t readily available – so let’s start with symptoms of companies with weak cash flow processes:
- Unplanned line of credit drawdowns
- Unusual holding of vendor checks
- Unexpected low cash balances
- Calls from vendors about collection
How can a business be run without understanding cash flow? How do you plan your future disbursements – purchasing and shareholder/owner distributions? How do you measure the adequacy of your cash collections? Even companies with strong cash flow need a cash forecasting process.
In a perfect world – every company should be able to project their cash flow at least four weeks in advance – within 85% accuracy. Greater than four-weeks projections are generally based more on strategy in anticipating sales and purchases as well as the timing of non-working items such as capital investment, debt and shareholder distributions. A strong thirteen-week cash flow is a combination of known short-term data and educated projections.
WHY A THIRTEEN WEEK CASH FORECAST?
Are you ever surprised with that dreaded message from accounting that informs you of short-term cash flow issues? Every company has a fiduciary duty to understand their liquidity – it is only fair to vendors, customers, banks, shareholders and employees. A thirteen-week cash forecast will minimize “surprises” and allow you to understand, in advance, the issues happening today that will have an impact on your future cash flow, and more importantly, performance! When asked why or what is the overall benefit of a thirteen-week cash flow – I find it best explained by sharing examples of real issues where cash flow forecasting was leveraged:
| Background / Issues | Identified by Cash Flow | Solution |
| Large doctor practice billing department claims were unknowingly not being submitted electronically to Medicare. | Treasury identified two weeks of weak cash collections – communicated this to the billing department. | After notifying billing of the weak cash trend – a system glitch causing electronic billings to be delayed was corrected. |
| A company with weak accounts payable staff and processes. Vendors were pulling services due to unpaid invoices. | Checks disbursed for invoices not entered in the system timely. Detected when comparing actual disbursements to projected cash disbursements per system report. | Transactional process issues were corrected. System reports were created to monitor the timing of invoice entry and cash disbursements. |
| A company with a weak cash conversion cycle unaware of the financing needed to fund future purchase orders. | 13-week cash flow forecast estimated the impact of known purchase orders–the forecast created negative cash balance 8 weeks in advance. | Enough lead time existed to obtain liquidity to cover the purchase orders through a combination of a capital call and debt financing. |
| A company divested a profitable/cash flow positive business unit. | The cash forecast was adjusted as a result of the divestiture – a negative cash deficit three months in advance was projected. | Shareholder distributions were delayed/reduced in advance to ensure cash was available and bank covenants were met. |
ROADMAP TO A STRONG FORECAST
A strong cash forecast takes time to implement and requires regular maintenance. Keep in mind though, low effort processes can be built immediately. See below for a list of common implementation tools which will lead you to a strong cash forecast:
Short-term/4-week projections:
- Immediately begin tracking cash flow at least weekly – cash inflows, trade disbursements, debt paydowns and payroll.
- Generate online cash activity from your bank of record for previous periods to identify recent trends. Utilize those trends to understand cash volatility on a daily/weekly basis.
- Develop projections based on accounts receivable, payables and payroll.
- Future cash receipts based on the customer accounts receivable aging due date.
- Utilize system reports such as the cash requirements or account payable aging’s sorted by vendor/invoice to project future accounts payable.
- Future payroll estimates based on pay date.
- Weekly – explain/understand differences between expectation/projection and actual cash balance.
Beyond 4-week projections/assumptions:
- Utilize budgeted revenue, margin and other expenses to develop long-term cash projections.
- Utilize average days in receivable and payables to develop timing of expected receipts and payments.
- Factor in any future capital investment, debt/interest, shareholder distributions and financing.
- Analyze the sales pipeline and compare actual weekly vs. budgeted sales – re-forecast future collections on a weekly basis.
Conclusion
Cash flow forecasting comes in all shapes and sizes and varies based on company type. Robust cash processes can be immmediately implemented for companies with straightforward and consistent cash inflows/outflows. Companies with complex cash inflows/outflows lead to greater challenges to project cash (e.g., start-up, tech, long-term milestone contract based, professional services, etc.). In these instances – the forecast may sometimes be more art than science – this ok as long as results are always compared against expectations and future forecasts are improved.
Remember – start small with a weekly forecast – (1) develop expectations, (2) compare expectations to actual results, (3) refine the forecast model and (4) do it all over again the following week!
About Lake Michigan Partners
Lake Michigan Partners is an independent management consulting firm located in Chicago, Illinois with projects managed nationally. We specialize in creating value for our clients by assisting them with complex special projects. The firm provides financial, accounting, business process and risk consulting and our team works with clients to align the company’s support activities with the organization’s overall business strategy. We work as an extension of management to execute special projects or specialized services.
Lake Michigan Partners is focused on improving reporting, accounting and the entire overall back office. We are consultants as well as resources – interim and part-time CFO’s and accountants.
Learn about us at www.lakemichiganpartners.com