A key aspect that determines the financial health of your business is how well you understand and manage your cash flow – how much money is flowing in and out of your business at any given time. This might seem obvious. You generally know how much money is coming into the business, but are you on top of how quickly or slowly you are being paid by your customers? Have you figured out how delayed your customers might be in paying you if you go into lockdown? And have you made a contingency plan or saved up for an emergency?
In this post, we will break down what cash flow is, why keeping on top of your cash flows is critical, especially when we keep going in and out of lockdowns, how you can improve your cash flows to reduce the stress on you and your business, and of course, talk about how your cash flow forecast impacts your ability to get a business loan and your business loan interest rate.
First, the basics. What is a cash flow forecast and why should you care about it?
Your business cash flow is the net amount of cash and cash equivalents that are transferred into and out of your business.
The health of your business and how fast it will grow is directly tied to your business cash flows. Your ability to survive the new COVID restrictions and lockdowns this year will depend on how well you take stock of your past cash inflows and outflows. This will help you estimate your income and expenses in the coming year and manage through what is certainly going to be an uncertain time ahead.
If you don’t have a handle on your cash flows, you are at a greater risk of straining your relationships with your employees and suppliers and impacting your ability to pay key bills, keep your employees happy and ensure that you keep your statutory obligations (like taxes) up to date.
When you are looking for a business loan, lenders place considerable weight on whether you manage your cash flows well. A well-managed cash flow shows a lender that you are likely to be able to repay the business loan they give you and whether you will be able to repay it on time. This is why lenders spend time analysing your bank statements and care about whether you always have a certain minimum balance in your accounts. In addition to your bank statements, lenders also review your Income Tax Returns and GST Returns to ensure you are running your business responsibly. You will always get better terms and rates on your business loan if you can show a healthy cash flow and provide these documents.
Have more questions about applying for a business loan? We’ve spelled it all out for you here. When you apply for a loan with CreditEnable, we get to know your business and match you with the right lender and product that meet your business requirements. We do all the work to find you the right business loan from more than 22 top lenders who can offer you 100+ specialised SME loans.
Managing your cash flow and creating a cash flow forecast
Building a cash flow forecast isn’t as complicated as it might sound. All you need to do is sit down and account for how much money went in and out of your business last year and what you think your inflows and outflows will be this year. Normally, businesses prepare cash flow forecasts for a 12-month period. But based on your needs, you can create a forecast for a shorter duration. Your forecast should include estimated sales, expenses, and business income. If you’re already working with a CA, they can also help you prepare a good cash flow estimate.
At uncertain times like right now, effective cash flow management and forecasting also help you save for any unexpected business expenses and prepare you better for what to do next.
Here’s a simple way to prepare a cash flow analysis for your business.
1. Cash flows are normally categorised into Investments, Operations and Financing. We have categorised them in an easy way for you below:
2. Once you’ve categorised what income and expenses go where, you can start to build your cash flow forecast for the next period (i.e., the next quarter or for the whole year).
There are two ways to forecast your cash flow: direct and indirect. Your business will benefit from a combination of the two.
Direct forecasting helps you identify when money will be coming in and out of your business in a specific period of time. For example, direct forecasting considers when a payment is actually received, not when the invoice was sent out to your customer. That means your forecast will be based on actual money in your account, not money that would be in your account if you received all your payments on time. Based on this information, you can plan for upcoming expenses and understand how much cash reserves you can put aside for a rainy day or for a rolling COVID lockdown when your business can’t operate as normal.
Indirect forecasting, on the other hand, is used to make longer-term predictions about your business based on your strategic goals and your historic cash flows. To create an indirect forecast, you need to take all the information you know about your business and how it has performed in the past. Then, you can map out what your business cash flows are likely to be in the future and what you can do to improve them.
If your business does a lot of day–to–day transactions (ie. you do a low volume of sales every day but for large sums), direct forecasting may be the easier method. Indirect forecasting is also more often used by larger businesses that generate many transactions and can more easily estimate their cash flow patterns based on larger volumes of transactions over time.
Once you decide on the duration of your forecast and your method of forecasting, creating a forecast is as simple as recording all your inflows and outflows in one place and estimating whether or not those are likely to change in the coming months or year.
For example, if you normally do sales worth Rs.10 Lakh per month and your monthly costs on inventory, advertising, rent, distribution etc. amount to Rs.50,000, will that change because you just landed a new contract that requires you to spend more on inventory upfront in the first three months but will increase your earnings after the third month? If the new contract does require extra inventory, will you have enough cash coming in to cover the extra expenses? A business cash flow forecast will help you answer questions like these.
If you want to build your own cash flow forecasts, there are many digital tools available that simplify cash flow management and forecasting for SMEs. Some of the ones we love are:
- Zoho Books: An online accounting software that manages your finances and ensures you are GST compliant while automating your business workflows.
- ProfitBooks: A simple and fast accounting software for SMEs. ProfitBooks lets you create invoices, track expenses and cash flows, and manage inventory without any background in accounting needed.
- Vyapar: A software that helps you track your income and expenses, reminds you of Receivables and Payables, and generates invoices and simple reports to help you track your business finances easily while ensuring your business remains GST compliant.
- TallyPrime: A software that allows you to input your inflow and outflow and generate reports that assess your business health from many parameters. TallyPrime is designed to make SME accounting easier.
If you have not prepared a cash flow forecast before and work with a CA to handle your business finances, ask them to help you prepare your cash flow forecast. They will be able to find patterns in your expenses and develop smarter strategies to keep your cash flow positive.
Matching your cash inflows and outflows
This is a challenging time for most “non-essential” businesses. As an SME, you need to work harder to keep your business operational and your customers loyal. To maintain a healthy cash flow, the gap between your outflow and inflow should not become too large. Here are some tips to ensure a healthy balance between your business inflows and outflows:
1. You are a small business and probably have intimate knowledge about what method your customers will use to pay and how long it will take them to pay. Based on this information:
- Start the process of collecting payments earlier from customers you know will take some time to pay their dues.
- Identify upcoming accounts receivables and those past their due date, so you can come up with a plan to collect them.
2. Based on your relationships with your suppliers, renegotiate supplier payment terms if you can so that you shorten the time between payables and receivables. If you have always paid your suppliers on time, they may be willing to help you out here.
4. Identify new sources of revenue to expand your cash inflow:
- If you know your outflow will be greater than your inflow in the coming months, explore ways to diversify your current business model to establish new streams of revenue.
- Explore business loan options. Working with our 22+ lending partners across India, CreditEnable has helped SMEs procure Unsecured Business Loans in just 3 days and Secured Business Loans in 10 days, free of cost!
A healthy cash flow is key to business survival and growth. You need to pay as much attention to it as you do your business operations and sales. Routinely tracking your cash flows will allow you to make smarter and more informed business decisions based on your business’ past performance. This will also help you tide over this round of COVID-related restrictions, plan your finances in case of further lockdowns, and increase your chances of qualifying for a business loan.
Once you have your finances in order, you can also explore digital platforms such as Google and Facebook to advertise your business to customers in your locality. Read more about that here.