Experts say cash flow forecasts can be tripped up by several common items that business owners and financial managers might overlook. Generally, these can be blamed on two factors: omission or over-optimism. We’ll discuss over-optimism later, but let’s start with common items left out of cash flow forecasts that can throw off your accuracy.
1. Year-to-year operational changes. A good forecast starts with what happened last year, but then you must consider what’s changed, according to Glenn L. Friedman, a CPA and managing partner of New York accounting firm Metis Group CPAs LLC. Maybe it’s pricing or promotional activity. “Maybe you’re doing an ad campaign you didn’t do last year, and you will believe it will generate X amount of revenue,” he says. Or maybe you’re planning an earlier ad campaign this year, so you will need to adjust the expected timing of revenue associated with that. In the case of service-oriented businesses, consider whether you plan to do some work earlier or later this year, Friedman adds. This is also the time to take a look at your client list and adjust your cash forecast based on the loss of a big client or the addition of several new ones.
2. Non-expense payments. Friedman says people often think about cash flow using their profit and loss statement. “They forget that there are cash requirements in balance sheet items as well,” he says. Repayment of debt is one example.
3. Infrequent items. Other common omissions include estimated tax payments for employees, monthly loan payments, periodic contributions to retirement plans or savings, and occasional expenses tied to unexpected surprises, such as equipment repairs or automobile maintenance.
4. Seasonality. Most businesses have busy and slow seasons, so taking that into account as you estimate cash outlays for inventory or staffing can help avoid a cash crunch. How holidays fall on the calendar can affect a retailer’s year. If you sell ice-removal products and last year was an unusually icy winter, you may need to plan for a more normal business pattern this year.
5. Commodities. Fluctuations in commodity pricing or currencies can be difficult to price ahead of time, but it’s important to take these trends into consideration when estimating your cash flow.
6. Capital expenses. Otis says forecasts can be spoiled if you omit property, plant or equipment investments for repairs or replacements or when something has become technologically obsolete.
7. Payroll. Michael Cole, audit principal at Southern California CPA firm Holthouse Carlin & Van Trigt LLP, says payroll can often cause big mistakes in cash flow forecasts. “If companies pay people on a monthly payroll or weekly payroll, then every seven years, they’re going to have an extra pay period,” he says. If they forget to plan for that, they could come up short for payroll, he adds. Similarly, cash outflows associated with annual or holiday bonuses or with quarterly estimated tax payments for your employees can be substantial enough to cause problems. Finally, don’t forget that staff turnover creates something called “productivity churn,” which has an impact on cash flow. Michael Voie, a CPA and partner with Stallcup & Voie LLP in San Francisco, suggests that if you lose an employee, determine how that person affected your business relative to his or her replacement. And it’s not just salary and benefit costs. “Are they a production person, and were they putting in 250 units a day and this [new] person is putting in 100? What if sales come in less?” he says. You need to think through the variance that will occur because of those changes.
Optimism confounds forecasts
The second general culprit of errors in cash flow forecasts – over-optimism – is pervasive but understandable, experts say. “Business people by nature are optimistic people, and that hurts them when they’re making cash flow projections,” says Lauren Prosser, manager of advisory services at Sageworks.
Here are several ways that too much optimism can confound your cash flow forecasts:
8. Sales and payments. By far, the most common issue cited by financial experts is when you’re too optimistic about when sales will occur and too optimistic about how soon customers will pay. “Don’t forget that a customer may say, ‘The check is in the mail,’ but you can’t spend those funds until the check has been deposited in your bank and cleared successfully,” says, David Douglass, a partner with Atlanta-based professional services firm Tatum.
9. “Averages.” In quickly changing times, averages used in your cash flow projections might [become] inaccurate, Douglass says. “For example, if your customers generally pay in 30 days after being invoiced and then suddenly delay payment for an additional 15 days, the extra 15 days often means you will have to cover another payroll,” he says. “There’s hardly anything worse than not having enough cash to cover payroll.”