Financial discipline ensures healthy cash flow

One of the most important, if not the most important, aspects of a business is having a healthy cash flow.

Poor cash flow management is the main reason businesses fail.

A business can have a high turnover and be profitable but if the sales are not turned into cash, the business will quickly run out of money and fail.

In business, Cash is King.

Cash flow is the life-blood of all businesses, particularly start-ups and small enterprises. As a result, it is essential that businesses predict or forecast what would happen to cash flow to make sure that the business has enough to survive when payments are due.

There is a popular misconception that if a business is profitable then it is successful.

A business has never failed due to profitability but many have failed due to poor cash flow. The profitability of a company does not represent the true health of a company as capital expenditure is not reflected in the profit and loss account.

Main advantages

The key benefits of preparing a cash flow forecast are the following:

It identifies potential shortfalls in cash balances in advance – the cash flow forecast is an early warning system for a business. This is, by far, the most important reason for preparing a cash flow forecast. For example, if your customers are taking a long time to pay, it will have a negative impact on your cash flow and your ability to pay expenses.

It ensures that a business can afford to pay suppliers and employees. Suppliers who do not get paid will quickly stop supplying the business. If employees are not paid on time, they will become disgruntled and could stop working or leave the firm.

A cash flow forecast identifies problems with customer payments – preparing the forecast encourages the business to look at how quickly customers are paying their debts.

If your customers are slow at paying, you may be missing out on early payment discounts on payments your business makes. It may also indicate that you need to offer early payment discounts as an incentive to encourage your customers to pay sooner.

It is an important discipline of financial planning – a cash flow forecast is an important tool in the management process of any business, similar to preparing business budgets. It enables the business owner to monitor how the business is performing and it will highlight any areas of concern. The earlier action can be taken to resolve an issue, the lower the cost to the business.

Capital purchases show up as an expense – a cash flow statement includes all the expenditure the business is going to make and will therefore highlight if too much capital expenditure is being made. It will also enable you to decide on the most appropriate way to finance any capital expenditure.

With regards to financing, only the interest element of the repayments is reflected in the profit and loss account. Loan repayments can be sizeable and therefore careful planning is required to ensure sufficient cash is available to make the repayments.

Banker’s need

In addition, external stakeholders such as banks may require a regular forecast. If the business has a bank loan, the bank will want to review cash flow forecasts at regular intervals to ensure that the business is not going to default on the loan.

A bank will expect cash flow projections as part of a business plan before lending funds and will want to monitor the progress of the business against the forecasts.

You may also be able to secure better lending rates.

Knowing when your business is going to be low on cash will enable you to plan when you may need short term financing and give you time to secure the best rate for that financing.

Preparing forecast

Whilst a cash flow forecast is an important tool in any business, it will only be effective if it has been prepared on accurate and realistic information. If the underlying assumptions are too optimistic, it will mislead the reader in to a false sense of security that the business will have adequate cash to meet its commitments which may not actually be the case.

Therefore, cash flow forecast must be realistic and must incorporate as much relevant information as possible. When preparing a forecast, it is essential that the following steps are adhered: (a) Involve key staff in cash flow awareness as they are running the business on a day to day basis. Ask your key staff to tell you immediately of anything that could substantially alter your cash flow. (b) Regularly compare the forecasts with your real cash position so you can see where to make improvements in your business processes and how you are tracking (c) Build pre-set warning signals into your forecasts. For example, you could decide that when you come within 10% of your overdraft limit that you’ll draw on cash set aside in another account or seek external finance.

Maintaining and reviewing a realistic cash flow forecast will be instrumental to the success of any business. Planning ahead ensures that you do not have to make rushed business decisions which could be detrimental to your business.

DFK Oswin Griffiths Carlton is a firm of Chartered Accountants providing the full range of business advisory and taxation services. Its experienced staff can advise you on all aspects of your business from both a domestic and international perspective.

Steve Darnley is an Associate Director at DFK Oswin Griffiths Carlton based in Auckland. For further details, please contact him on (09) 3793890; Email:

DFK Oswin Griffiths Carlton is the Sponsor of the ‘Best Businesswoman of the Year’ of the Indian Newslink Indian Business Awards 2014.

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