recession busters: cashflow forecasting is a critical tool
Kevin Johnson, corporate finance partner at Spofforths Chartered Accountants, argues that forecasting cashflow is an essential tool
Many businesses across Sussex will be experiencing the acute pressures created by a declining economy. The latest government figures show that the national economy is flat-lining and could easily tip into a recession. Businesses of all sizes have seen their profitability erode. Some have experienced customers cancelling orders, attempting to defer payment or stop trading without paying their outstanding invoices.
Under favourable trading conditions, core financial techniques should be in place in any well-managed business. But in strained circumstances these become absolutely essential.
Key among these techniques is cashflow forecasting. This gives financial managers the opportunity to understand how a business might fare if orders decline and customers fail to pay their bills. Cash is central to keeping the business going. Managing and financial directors need to ensure that they have sufficient cash to pay staff, order stock, promote products and services and meet obligations.
Companies are also experiencing a profound tightening of credit lines from their bankers. Where banks have been generous with loans or overdraft facilities, this policy is changing. Certainly, businesses are finding banks less willing to extend credit and even, in some cases, looking for means to achieve early recovery.
With effective cashflow forecasting, such managers can identify when cash shortages or pinch points against loan covenants are likely to occur and are, therefore, able to plan effectively for whatever circumstances could unfold. Without such techniques, companies may not have sufficient time to take action when problems arise and this can have serious consequences for the ongoing health of the enterprise.
Setting up a cashflow system will require some effort by a company, but once it has been established it should be straightforward to operate. The internal resources required will vary according to the complexity of the individual reporting lines in each business. In most smaller companies, however, they are usually easily understood.
One of the chief causes of cashflow problems is late payment. Many customers may try to renegotiate payment terms. They may want longer to meet their obligations and even some discounting on the original price. The cumulative effect on individual enterprises could be devastating. Company directors may be forced to consider unpalatable choices such as laying off staff. But having an operating cashflow management forecasting system can be the difference between survival and insolvency.
Early trend information allows decision-makers to take informed choices. For example, some customers may respond well to a discount of perhaps 2-3% on the total outstanding. While this is probably very little in terms of the actual amount, some customers will respond. This is partly, I suspect, because it demonstrates that supplier and customer are both in the same fix. And a small discount means recognition of shared difficulties.
Many of our clients have asked us to introduce cashflow forecasting systems for their businesses. They report that these systems have been hugely beneficial to their effective management and the long term longevity of the business.
kevinjohnson@spofforths.co.uk
Date:1 October 2008