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Going With The Flow

CASH FLOW PROJECTIONS ARE A GOOD WAY TO TAKE A CLOSE LOOK AT YOUR COMPANY. THE PROBLEM IS FINDING THE TIME TO DO THEM.
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Three years ago, R. J. Martin Co. had reached $1 million in sales by preparing such audiovisual materials as slides, graphs, and videotapes for large corporations, including American Telephone & Telegraph Co. and CBS Inc. In order to ensure its continued success, company president Richard J. Martin realized he would need to purchase state-of-the-art video equipment, then priced at $180,000.

Martin immediately ruled out borrowing, because of the high interest rates. Instead, the Palisades Park, N.J., company came up with a somewhat unorthodox solution. Why not ask the video-equipment manufacturer to carry the account long enough for Martin to pay the bill out of his company's normal cash flow?

In making his proposal to the manufacturer, Martin had an important -- and somewhat rare -- weapon: a detailed, intelligent cash forecast. "I showed them the forecast and proposed that I pay them over nine months at no interest," remembers Martin, whose company has grown to $2 million. "They were so impressed that I had a forecast at all that they agreed to my terms with only one exception. They wanted their money a little sooner than I had proposed -- in six months."

By and large, private companies with less than $5 million in annual revenues don't do formal cash forecasts. Many of them either lack the in-house financial expertise necessary for the job, or they are not willing, or able, to pay an outside expert to do the work for them. Accountants and financial planners charge anywhere from $50 to $200 an hour for forecasting, which can take days to complete.

Time, however, is the chief excuse that small business owners use for not preparing cash flow projections. "A lot of entrepreneurs are operating by the seat of their pants, so the real chore is getting them to sit down and decide how they're going to operate for the next few months," says Daniel J. O'Brien, a partner in the New York office of Coopers & Lybrand.

Cash flow projections make a lot of sense for a lot of reasons. For example, they force companies to address operational issues in a timely fashion: Will fringe benefits be changed this year? When will a new product be introduced? How much more will be spent on advertising? Will overall debt be slashed?

Cash flow forecasts also compel corporations to decide -- in a proven, systematic way -- how much inventory to maintain and when additional people must be hired. Royal Silk Ltd., of Clifton, N.J., is a case in point. The $21-million company, which sells blouses and other silk garments by mail order, has installed a sophisticated cash forecasting system to track the number of items it sells per advertisement and per mailing list. That information enables it to estimate accurately how many blouses it must have in its warehouse when, for example, it takes out an ad in the July issue of Cosmopolitan magazine. It also knows how many people it must hire to take telephone orders.

Cash flow projections also can be used to motivate employees. For example, Sillerman-Morrow Broadcasting Co., of Middletown, N.Y., shares its monthly sales estimates with employees of its eight radio stations. The stations then use these figures as their sales goals. If a station exceeds its stated goal, its salespeople share a bonus that equals 4% of the revenues in excess of the amount projected.

Even more importantly, cash flow projections are key to long-term fiscal prosperity. Done right, a cash forecast can predict a company's cash crises months, even years, in advance, so that a business owner doesn't wake up one morning and discover that his corporation can't pay its current bills. A cash flow projection buys chief executive officers the time they need to raise capital. And it enhances their credibility with lenders by demonstrating that the company has a handle on its day-to-day finances.

"I don't care if the projections are done on a computer or with a pencil," says Frank J. Pipp, an assistant vice-president of First Wisconsin National Bank of Milwaukee, which has some $3.5 billion in assets. But the numbers must be on target and based on hard facts, such as a small company's sales and purchasing history. In addition, the corporation's CEO must possess a solid working knowledge of the documents.

"The worst thing," Pipp notes, "is when the business owner doesn't understand the numbers himself. If I ask a few simple questions, and, right off the bat, he hesitates, that's a clue that there's a problem -- a serious problem. And that makes me . . . hesitant [to make the loan]."

Another red flag, in Pipp's opinion, is a business owner's inability to explain how a change in one number (the time it takes to collect accounts receivable, for example) affects the rest of the forecast. "What happens if inventory isn't selling as fast as you thought?" he asks. "What does that imply on the liability side? Are you asking me for too much or too little?"

As a rule, Pipp says, business owners are overly optimistic in their cash projections. He blames this on the fact that many of them prepare their cash forecasts "in a vacuum," meaning that they don't consult their key sales and purchasing employees.Across-the-board participation in a cash forecasting process, Pipp stresses, helps assure accuracy. That's because lower-level staff members "are closer to the company's customers" and aren't likely to be pulling figures out of a hat. Sillerman-Morrow Broadcasting, for example, goes so far as to ask each salesperson at its radio stations to estimate annually how much each customer will spend on advertising. "It's not very scientific," concedes Richard C. Bell, the $7.2-million company's chief operating officer, "but it works."

Perhaps the biggest mistake business owners make in cash forecasting is not comparing the projected figures with a company's actual performance. Frank V. Payne, president of USTEP Corp., a financial planning and business management firm in Cincinnati, calls this procedure variance analysis. "Say you project $10,000 in revenues in one month, but the company does $12,000. You need to know why you did $12,000," he says, "so you can keep on doing it."

Last updated: Mar 1, 1985




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