Why Every Business Needs Long-Term Cash Flow Forecasting
Posted on 27th September 2017 in The Forecast
Written by Freya Hughes
Looking up to the night sky, you realise how small we are on our planet. The sheer size of space, something we can barely get our heads around, accompanied with how far away it is reminds us we lack control. While in the universe we have pretty much no say in what happens, you can use a forecast to see projections for our economy and the obstacles that may trip you up. If you think about how much impact a short-term forecast can have on your business, looking further ahead still will definitely give you a sense of security.
Running your business, you may feel that looking at what has already happened is the best way to project what will happen next. In reality, though, it’s not the best way to operate. Looking ahead to the future with the help of the present will give you a solid idea of how you’re performing, and where you need to amp things up. You need to be sure that more cash is flowing into your business than flowing out, and you’ll only know this if you forecast.
So when you’re operating day-to-day, and have plans for your business to stand the test of time, you need to be forecasting both short and long-term. To bring this right back to basics, here’s a quick breakdown of the differences you’ll see with these different time frames, and then we’ll have a look at the benefits of looking further into the future.
If you’re looking ahead to a short-term, perhaps a year or under, then you’re just looking at what will happen immediately. You’re probably already doing this to an extent as you always need to know how things are looking so you can judge what decisions to make about investing in new stock, or similar. A great example of a short-term forecast which would last a month or two is in retail. Let’s say you’re putting on a sale to get rid of some of your old stock. You’d put the new reduced prices into the forecast to see how much revenue you’d get from it, for example.
Longer-termed forecasts will include such things as economic peaks and troughs, inflation and politics. Because we can never know exactly what will happen next – think Brexit and Trump – creating a long-term forecast will only ever be a guess. However, because you’ve created one it’ll help you to think outside the box about where the country/world economy may be, and how you’ll build your business to the point it can withstand these changes.
It’s like if you were going for a job interview. You’d plan your short-term by preparing for the questions, sorting your smart attire and journey to the offices, etc. Many people may not see past the interview itself, focusing all of their energy on charming the interviewers and making themselves come across well, but what if you do (or don’t) get the job? You need to have a contingency plan for both: if you don’t get the job it’s back to the hunt, but if you do then you need to be ready to excel in the role and fit in well with the team. Thinking of this in this way is easy to relate to, but you need to be thinking in this short/long-term way otherwise you’ll back yourself into a corner.
But back to (your) business. You’re running your company well, but how do you know how you can achieve sustainable growth? How do you know if each and every employee is working to the best of their ability? Do you know what you’d do if X, Y, or Z happened?
To grow sustainably, you need to have a really deep understanding of your figures. This can only happen if you’re constantly checking in with the ins and outs of your accounts, and forecasting for different eventualities. You’ll know when you’re due to be paid, when you need to pay out to suppliers or similar, and can adjust if need be.
In some industries, like manufacturing, a lot of costs can occur up front, so knowing you have enough cash for this before you’ve even sold anything is crucial. Similarly, invoice payments can be delayed and sometimes you simply won’t get your money on time. People conveniently forget to pay, go into administration or whatever else, so having a backup plan for such things is imperative. Using your forecast, you can add scenarios (more on those shortly…) to ensure you have a ‘plan B’ for these kinds of problems.
Hopefully, you’ve hit a point (or are approaching a point) where you’re feeling ready to expand. This may come in the form of taking on new premises, or hiring a new member of staff, or perhaps investing in some new kit. All of these are intended to impact your bottom line for the better, so when you are looking to do so, you need to know you can afford them.
So let’s use the new hire as an example. You need a new person to take over a few roles within your business, and think you can afford to hire straight away. Studying your forecasted figures in the long term is going to indicate whether or not this is a good plan; look at your sales figures and how they’re expected to look for the long-term. This will show you whether or not the investment in a new hire is going to be worth it, and if anything went awry if you could still afford it. When we spoke to John Ryder, owner of Hive.HR and specialist in employee engagement, he told us an estimated cost of replacing employees is 150% to 250% of annual compensation figures. If you think about this figure, could you afford a new member of staff or is it better to ensure your existing team are happy, engaged and even ready to take on more responsibility.
So as mentioned earlier, adding scenarios is going to give you a lot more flexibility with your decisions. When you’ve created your long-term forecast, you can add a base scenario with best, middle and worst case results. In the long-term, you could plug data such as inflation, or political changes (read: when your country decides to cut a long-standing economic support structure), therefore giving you an idea of what could go really wrong – or right.
As you plan for different outcomes, you’ll notice your business looking stronger and ready to cope with anything the world throws at you. Imagine a very basic example: you want to buy new equipment. You’d want to know that, firstly, you’d have enough in the bank, and, secondly, that you’d get a good return on that investment before you went ahead with the purchase. Using scenario planning you can, as previously mentioned, see your best, middle and worst cases, built on top of your base scenario. You’re going to notice that these various outcomes allow you to prevent negative occurrences, rather than have to cure them.
A real-life example comes from Michael Tyrell, owner of Beautiful Print company. We spoke to him recently to find out just how he used scenarios and forecasts to ensure he could get a return on his investment in new equipment. Read the case study with Michael to see how he achieved funding and made his decision with confidence.
You’re able to make life-changing business decisions with confidence: look to the future and ask yourself where you want to be next year, the year after and in 5 years. In all likeliness, you’re spending most of your days fire-fighting, but scenario planning will see this become less and less necessary. It’s there to help you navigate the uncertainty.
KPIs: a granular view
So your long-term forecast is going to show you where you could be. Measuring key performance indicators is a great way to see how you’re going in the present, so now try making them key predictive indicators. The difference, as you’ve probably guessed, is that you’re looking at what might happen, instead of looking at what is happening. This is a great way to operate, forcing your head into what’s next. If you’re using your metrics as predictors, you can set long-term targets, and know (by regular results) if you’re on course to hit them.
They’ll give you a granular view of your business, by department, even by employee. Predicting an employee’s performance far into the future will give you a view of how they should be performing now. You’re giving yourself a good view of your team and how things should be. Similarly, if your key performance indicators flag up an underperformance in a certain area, your predictive target can be to combat this issue. You can use them almost like an internal benchmarking tool.
Get a competitive advantage
While forecasting can mean the difference between open doors and a padlock on the forever-closed premises which was your business, it can also take your business from being good to great. If you think about who your competitors are, and feel they always seem to be one step ahead, the chances are they’re forecasting their figures. You can easily overtake their lead by using a forecast, as each decision you make will be well thought out, and made with confidence.
If you’re reading this thinking, ‘when on earth will I find time to check my forecast so regularly?!’, then don’t fear. We thought this a little while back, so made sure there’s a way of knowing you’re doing well without even having to check. You can set your account to alert you, via email or in-app notification, as to when your cash levels are getting low, or you’re about to exceed your buffer limit, for example.
Your business keeps ticking even when you’re asleep, so it’s understandable if you find you rarely get a proper rest. FUTRLI monitors your business as you sleep, and if you’re really worried, you’ll awake to warnings. Otherwise, get your head on your pillow and get some well-deserved sleep – when you wake up, you’ll be notified if anything is looking worrying. You trust your phone to ring if something happened to a loved one, so allow technology to protect your finances too.