You may think that if you can’t reliably forecast your sales, then what’s the point in trying to use Cash flow Forecasting as a planning tool?
Things can change so quickly from one month to the next. There are some Businesses who predominantly sell on line, direct to customers, where the order pipeline is hard to see. Even if you are not involved in online selling, maybe your orders come in quite ‘randomly’. A good example of this, is in retail, where your sales are determined by footfall. Seasonality and the environment, as well as where your shop is located can also be determining factors which are variable over time.
In my quest to constantly look for different reporting solutions for Small Business Owners, I would suggest that you can still use cashflow forecasting to help you grow your business. However, I would propose an alternative method.
I refer to this method of cashflow forecasting as creating an “upside down cashflow forecast”. Instead of starting with the sales forecast, we start with the costs and work backwards.
By only using the figures we know, we give ourselves certainty of what sales we need to achieve and to what timescale.
We must however always concentrate firstly on what we know.
How to Collect the Data you know.
The first step is to collect all the cost data on what you do absolutely know. This will relate to the Fixed Costs for your business. So, this would include things like rent, rates, electricity, the cost of employing admin type staff and those on a fixed monthly salary. Any costs in fact that you would incur, regardless of if you make a sale or not. Aswell as knowing the cots we also need to establish when these costs are paid out of the business. What are annual fees, quarterly or even half yearly.
By determining the size of the fixed costs pot which hits each month, you know, , how much costs you need to cover in order to stay afloat.
Remember to recognise these costs by asking yourself,
“Would I still incur these costs, even if I made no sales in the month?”
Now, there will also be costs that you will incur, but only when you make a sale. These costs are called variable costs and may include things like;
You will be able recognise what these costs are for your business by asking yourself,
“For every additional sale, what are the costs that increase?”
For your variable costs, you need to be able to turn these costs into a metric. The metric that is important to understand for your business is the Variable Costs/Sales ratio.
So, for every £1 of sale you made, what is the cost of the additional or variable costs to your business.
A 60% ratio means that for every £1 Sales revenue you make, it will cost you 60p in direct variable costs and hence your gross profit is 40p.
Sales – Variable (or Cost of sales) = Gross Profit
Once you understand what your Gross Profit is as a % of sales, you can now use this very powerful metric to help you get visibility of what level of sales income you need to generate in the future.
Create the Spreadsheet
Now you have the knowns, its time to use your spreadsheeting skills to pull this all together in terms of
- Costs that need to be covered-Fixed Costs
- The Gross margin that is required to cover your fixed costs.
The sales figure is therefore forced out by using the formula Fixed costs/Gross Margin %
A simple example may look as below
How to Use the Upside Down Cash flow Forecast.
When you can quantify what sales, you need to achieve in order to cover all your costs, this will help you enormously when planning forward for your business. There are 3 specific areas that you will gain insight in:
- Understanding the Size of your Sales gap
When you quantify the size of the sales gap this can be enormously insightful. It really does give you a feel for what needs to be done today and what can be worked on in a few months’ time. The actual size of the gap will also enable you to see, what is realistically achievable. Now you have the figures you can turn your attention to thinking about options to bridge the gap.
- Work on Options and Scenarios
I know as the Business Owner you’ve always got to remain optimistic about the forward Sales. This is fine, but it’s also sensible to consider some contingency options if, for whatever reason, the sales don’t materialise.
Scenarios can be factored into you ‘upside down cashflow” by removing, reducing and retiming costs, where you are able to flex these. Both longer- and shorter-term options should be considered so that you have a level of sensitivity analysis. This allows you to still achieve a breakeven position, even if sales are lower in any one chosen month, or overall by a certain %. Thinking through these scenarios now will enable you to move much quicker and flag when you need to act,
The mind has a strange way of going into panic mode when poor sales hit. Rational and objective thinking is best done when you have the luxury of not having to react straight away!
- Reassess your Existing Plans and Commitments
When you quantify the sales gap, this enable you to reassess the level of inputs you and your business need to make in order to achieve the target Breakeven Sales. Often it can give you the realisation that you need to increase marketing and advertising effort. It may highlight that you need to increase or focus on business development to have a chance of really being able to generate the sales you need. This will start off a whole cycle of planning around whether the additional costs of inputs will pay black in terms of the sales that you need.
But that’s another blog, and you can read all about that here.
Less Stress and more Certainty
So next time you think Cash flow forecasting is not something that’s useful to your business, try this alternative approach. You know it makes sense to not just trundle along from one month to the next. Blindly hoping that sales, somehow, cover your costs.
By being able to forecast your outcomes, this will immediately reduce your stress of not knowing your numbers. This will give you incredible insight and most importantly it will give you time to think about what actions you need to do now, what to prioritise and what you should stop doing, in order to ensure you build a business which does not run out of cash.
Looking for help?
Why not check out my services page to see if I can help you with your Financial Management and Control issues.