I was giving a keynote address to a group of medical practice business owners when one of the people in the room came up to me after and shared about his cash flow challenges. His practice was generating just shy of $3 million dollars a year in revenue, but he felt anxious because he never knew where he stood financially. Would he have enough cash in the bank to cover payroll? Would he have to put in cash from his personal account as a loan to the company?
His real problem wasn't that the business wasn't profitable, it was. The prior year he had over $650,000 of owner compensation. But he had no way of predicting the inflow and outflow of cash.
So I shared with him one of my favorite cash flow management tools - the rolling 120-day cash flow forecast. I've used this tool for years with our business coaching program clients and have found it to be a simple yet powerful tool to manage cash flow.
Here's how it works. Export the prior 12 months "profit and loss" out of Quickbooks® or whatever accounting software you use. Use this as the basis to create a rolling forecast of cash in and out of your business.
Notice I said a forecast of "cash" in and out of your company, not profit. Remember, cash and profit in the financial view of your business are two distinct things. Profit is what shows up on your "P&L"; cash is something that comes into and out of your bank account.
Starting with your P&L, make the following adjustments to your forecast:
- What cash payments are recurring? You should see this in your P&L anyway. Are the amounts accurate for the next 120 days?
- What about other non-recurring payments coming up in the next 120 days? Make your best educated estimate here.
- Any inventory or other cash expenditures that don't show up (yet) on your P&L that you need to factor into your cash flow projection? (Remember, inventory costs cash but isn't booked as an expense until you sell the product or write it off. Also, any loan principle you pay on equipment or real estate costs cash but isn't an "expense" item on your P&L. Make sure you account for this on your cash flow forecast.)
- Look at your income side. What cash can you confidently expect to collect in the next 120 days? Make sure that is accounted for in your spreadsheet forecast.
- Factor in any new sales you expect to make and be paid for (remember, this is a forecast of cash, not of promises of future cash. If you tend to collect slowly, you need to be honest in your forecast.)
- Any issues from seasonality or market trends that you need to account for in your forecast.
Now that you have this, every month review what your "actual" income and expenses, and look at the "delta" (just a fancy way of saying what the difference was for income and expense items.) Your goal is to train your financial muscles to consistently improve the accuracy of your cash flow forecast by reducing the delta, month by month.
My final comment is to remember that this forecast is not the same as your P&L projection, rather this is a projection of your cash flow. Again, I see so many business owners get into trouble when they think the "profit" showing on their P&L is equivalent to cash in the bank. It most assuredly is not. While this might not feel intuitive, practicing with your rolling 120-day cash flow forecast will help you strengthen this muscle so you feel greater confidence about this pillar of your company.