Any business that expects to survive over the long haul should do a cash flow forecast that shows cash expectations for at least one quarter. The forecast shows expected revenue from each major source and where it is expected to be spent. The cash flow forecast should be updated weekly. Businesses should analyze cash flow drivers and which customers and products are profitable on a cash basis.
Cash flow forecast ensures that there is enough cash left at the end of the day to meet obligations and still have some to invest back into the business. Cash not “net profits” is king.
It is possible to be a profitable business and still be broke due to poor cash flow.
So what is the difference between profits and cash? Profit tells you how much you have sold and spent over a period of time. However, just because you have sold something does not mean you received the cash for it. Cash on the other hand only counts when actual cash is received for a transaction. Cash flow and profit do not necessarily happen at the same time.
Poor cash flow is what eventually leads to bankruptcies. Some common causes of poor cash flow are rapid growth, poor collections practices, paying bills late (due to lack of organization, late bills means more fees) and poor money management habits. If you want to own a business, you have to learn or to tighten your belly if you are going to be successful: You cannot always have everything you want when you want it. Poor personal money management techniques flow into the business and eventually will bring the business down.
Poor cash flow means lost opportunities like buying inventory at bargain prices, expansion opportunities, etc. Most businesses with poor cash flow also have poor credit.
How to compute cash flow
Cash flow is computed by subtracting cash outflow from cash inflow. What makes cash flow forecasting so difficult is inflow and outflows do not occur at the same time in the same amounts every month. Some inflows are uncertain and some outflows are unexpected. However, the longer your business exists, the easier it becomes to predict these numbers.