Accurate sales figures are the most important steps in developing an estimate of the amount of money you expect to get and to pay out of your business (known as a cash flow forecast – more on this later). Unfortunately for new businesses, a lack of history makes it challenging to figure out the numbers. You have to know how much you plan to sell in the next 12 months, though, in order to plan how much to spend. This is known as a sales forecast.
An accurate sales forecast will:
- Increase your chances of business success
- Show the money/financial potential of your business and how likely it is that your business will succeed
- Assist a lender in understanding your business
- Tell you how much money you need and how long it’ll last
- Assist with your marketing and advertising.
So, as a business owner, you need to make sure you’ve figured out a price for your product/service, and that your product/service is actually priced to sell. You also have to consider if seasonal changes might have an impact on your business. For example, will winter interrupt Adnan’s honey business because the bees won’t produce as much honey then?
Take a look at this sample sales forecast from the Grow-Well business to get a sense of what a completed sales forecast would look like.
Cash Flow Forecasts/Projections
Cash flow forecasts or projections are incredibly important when it comes to running a business, especially because a negative cash flow equals business failure.
What is cash flow?
This refers to the money that comes in and goes out of your business.
Cash in = cash that comes into your business from selling its products/services
Cash out = cash that goes out of your business from producing its products/services
Managing your cash flow is all about planning. Successful cash flow management means you schedule cash to come in as soon as possible when you start your business and that you hang onto cash as long as possible. You achieve a positive cash flow when money is coming in to your business faster than it goes out.
It’s really important to be proactive rather than reactive – what this means is that you’re anticipating what might happen rather than reacting to something that actually happens. For example, Adnan could stock up on enough honey in advance to sell during the winter, so even if his bees aren’t producing enough, he can still make sales. If he plans for this before the winter, it means he isn’t scrambling to figure out a solution in the middle of winter!
Remember, you need to factor in anything that might impact your business when you’re figuring out your cash flow projections. For example:
- Seasonal changes and weather
- Community events
- Sporting events
- Other issues
Remember your STEEP analysis? It’d be a good idea to go back and review this, as there may be information you’ve already gathered that can help you.
Cash Flow IN
Cash Flow OUT
Maximize Your Cash Flow
It’s always good to try to look for ways to maximize your cash flow. This can be done by reducing expenses (where necessary and realistic); you might need to scale back a bit as you’re getting started, but that’s better than ending up with a negative cash flow. You can also try to get rid of unnecessary expenses, ask customers to pay cash for their purchases (to eliminate credit card fees, for example), or get customers to pay a deposit on large orders.
It’s also very important to invoice customers on time to ensure you get paid sooner rather than later, and that it’s clear when and how payment is expected, as well as any penalties for late payments. You can consider offering a discount on early invoice payment. You can also charge a deposit or retainer upfront for work in progress. It’s very important, too, to keep track of past due accounts and actively pursue collections.
Practice good cash flow management by
- Accurately forecasting sales and monitoring how quickly customers pay
- Developing minimum inventory policies and needs (i.e., figure out just how much stock you need and don’t overbuy)
- Developing effective payment collection and invoicing practices
- Controlling your cash outflow – turn sales quickly into real money in your pocket
- Knowing when you’ll need more cash (e.g., to restock, buy a new computer, etc.).
For an idea of what a completed cash flow statement/projection looks like, take a look at this example from the Grow-Well business.
The Operating Cycle
Now, let’s take a look at the operating cycle of a business. This refers to the number of days it takes for a business to receive inventory, sell that inventory, and collect cash from those sales. It can be split into two phases: the purchase cycle and the sales cycle.
The purchase cycle includes the steps taken to order and pay for products that a business requires, otherwise known as inventory.
The sales cycle includes the steps taken to sell inventory and collect cash. There could be a delay in your sales cycle between the amount of time the customer receives the product and the amount of time you receive cash. The amount that you are owed is called Accounts Receivable (AR). For example, Adnan would have an Account Receivable when he delivers honey to a customer on June 1 and the customer is allowed to pay 30 days from then.
How does knowing your operating cycle help your business?
Knowing the steps involved and your operating cycle timeline can help you strategize to shorten that cycle. It can help you plan your cash flow and forecast your sales. It can also help you achieve your financial goals.
How do you calculate your operating cycle timeline?
First, you need to figure out the steps involved, based on your type of business.
Remember, these are just examples of operating cycles; yours might be different depending on your business type and your customer experience map.
So, when can you calculate your operating cycle timeline?
Once you know the steps in your operating cycle, you can calculate how much time each step takes and then build a timeline. Take a look at the example below:
This timeline example includes 45 inventory days and 45 Accounts Receivable days. This means that, on average, there are 90 days in the operating cycle (i.e., 90 days between buying inventory and receiving cash from the customer for the sale of that inventory).
How do longer or shorter operating cycles impact a business?
The longer the operating cycle, the longer the business has to wait before it has more cash. If you’re paying for directs costs on credit, this means that your business could be charged more interest. For a small business, it could mean that production may slow down because there aren’t enough funds going into the business. You should aim to have as short an operating cycle as possible (without cutting corners) to be more efficient and successful.
How do you shorten your operating cycle?
- Speed up your sales of inventory – if you’re able to quickly sell your products, your operating cycle will decrease.
- Reduce the time for collecting Accounts Receivables – if you’re able to quickly collect cash from sales, your cycle will decrease.
A lot of the work you’ve done up to this point will help you as you work out the finances of your business. Go back to your customer experience map, look at your revenue streams analysis, review your process/production map, review what you need to do to deliver your product or service, and what resources and capabilities you need to make it happen.