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  • Peter O'Sullivan

Pssst….your profitable company will soon be bankrupt. This is how I know.

The first thing to understand is your CFO may not be able to see this coming – and it’s not her fault. Cash Flow forecasting is NOT (only) an accounting issue, it’s a Sales and Operations issue - which is why it is easily missed.


Here’s why:


  1. Accounting is designed to provide an accurate historical view of your business.

  2. Forecasting sales and operations is not part of any regular accounting methods.

  3. Most smaller companies do not have the resources to track future cash flows.


Even if you have a fat line of credit – you can be at risk. There are only two exceptions to this rule: 1. You have access to a pile of cash or 2. Your business is flat and incredibly predictable. If you are not in either of these categories – read on.


The Three-Step Checkup


Step 1. Calculate your Quick Ratio... but with great suspicion


Often companies look at the Quick or Acid Ratio to see if the company is in a good cash position. I have found that using this ratio is helpful but not the only view you need. A company should have at least a ratio of [(Cash + AR + Marketable Securities) / Current Liabilities] > 1. If you exceed 1, you should be able to pay your bills.


But the Acid Ratio can be misleading. For example, one company I worked with had not accurately accrued for Vacation Time. During a recent reduction in force (RIF), they discovered that an employee had over $40,000 in vacation time due. At termination, it would have reduced their cash position much more than keeping him on for another 6 months. Multiply that by 30 employees, and you can accidentally create an even more serious cash issue.


More importantly, the Quick Ratio can change at any time. If you are anywhere close to having a QR that is near 1, you’ll need to check and verify weekly.


Step 2. Scrub and analyze your Sales Forecast


Next, look at your sales pipeline. One way to look at it would be: [Value – COGS * probability] and organize by the timing of inbound cash. This is a non-accounting process that requires a clear understanding of both sales and marketing processes. You’re looking to understand the reliability of the incoming cash flow including existing contracts, the quality of proposals and the probability of future sales ALONG with the cash time frames associated with each dollar.


This is where a seasoned manager can spot a major issue. Scrubbing the sales numbers, understanding the conversion of marketing dollars to sales and documenting cash-in timing is the only way to ensure accuracy in the forecast.


Step 3. Gorilla Cash Flow Statement


Finally, take the income statement and make timing and value adjustments based on the previous analysis. From there you can create a 12-month (or longer) “gorilla” cash flow statement.


The graphic below is an actual Cash Flow forecast for a 20 year-old, profitable company who has an extremely seasonal sales cycle. We forecasted a Net Income of $478,120. Maximum cumulative cash out was $750,549. With this view, it quickly became apparent that they could not afford a payment delay from even one major customer. With a credit line of $600,000 – the (true) amount of cash in the Current Assets and the timing of incoming customer payments was difference between viability and bankruptcy.

Ironically in this case, if the company received an order in June that was $100,000 more than it had anticipated, it would likely be received with great fanfare – yet it could also bankrupt the company. Knowing this in advance would enable the company to possibly increase its LOC and better negotiate and track payment terms for that customer/order.


Better cash flow = greater profitability


After a profitable year, many owners of S Corps need to take cash out for taxes, personal use or investment. How much cash they can take out depends on their ability to manage the cash flow in the company.


If cash management is left only to Accounting, you may be surprised. Even for very profitable companies, the only time cash becomes a focus is when there is too little… and sometimes that can be too late.


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