How to Unlock the Power of Cash Flow Projections and Scenarios
I am obsessed with building cash flow projections and financial scenario planning. Seriously.
I’ve spent the last several months working with small businesses in industries hit hardest by COVID, including personal services (i.e. salons), daycare providers, and specialty retailers. In addition to providing technical assistance to support them in applying for grants and loans, I’ve been talking with owners about the business of their business.
We’ve explored marketing and sales strategies, ways to retain current clients, techniques for identifying and reaching new target markets, e-commerce implementation, re-engaging former clients, pricing, payment terms/collection, developing new products and services, using new distribution channels, and so on. Some of these things are feasible with the resources on hand. Other changes and pivots require capital—money not all businesses have to invest in new strategies and tactics.
Very quickly, the conversation turns to cash flow—how they are managing the flow of money in and out of the business, including cash and cash equivalents from operating activities, investment activities, and financing activities. The ability to manage cash flow is a critical business skill (not an accounting function). Cash flow statements help owners measure the relative strength, profitability, and long-term future outlook for their company. They also reflect the positive and negative impact of business decisions on the bottom line.
The Value of Cash Flow Projections
In addition to providing insight to the current and future profitability and sustainability of the business, cash flow statements and projections are tools that help us get a sense of how hard the business has been impacted by the COVID-19 recession, how leadership is feeling about Q4 of 2020, and what they think 2021 might look like—because these feelings and beliefs manifest as implicit and explicit business decisions.
More often than not, my clients only have a vague sense of these things. They know revenue is down and that they have cut expenses. They know what their bank balance is. They have a hard time imagining what the future—a few weeks to several months—might hold. They want to make decisions and act but are struggling to figure out the next best step.
Frankly, it can be scary to run the numbers and turn vague impressions into hard realities. And yet, I promise, it really is the best thing you can do to get and maintain control over your business. A lot of things are out of our control. We can’t force people to buy, or reduce many of our fixed costs. We can’t predict another lockdown or whether someone on our team will get sick. So we have to control what we can.
Cash flow projections for 2020 and scenarios for 2021 give us ways to identify the most important things to pay attention to and build plans for getting the outcomes we want.
For example:
I work with a specialty promotional product maker. Much of their business is driven by special events such as walks, runs, bike rides, family reunions, conferences, and other nonprofit and corporate events. They have a strong base of local small business clients and when companies started temporary closures, shifted to work from home, and canceled events, their business slowed down considerably.
They immediately looked at ways to save money (supplies, materials, reducing staff size and hours), pursued loan and grant opportunities, and brainstormed ways to keep sales coming in. Each strategy helped in different ways but until they plotted the actual revenue, expenses, and capital investments in Q1, Q2, and Q3, they really could not assess whether they had saved and earned enough or what it would take to break even by year’s end.
By doing the cash flow analysis and projections, they could very clearly see their current financial position, as well as what the remainder of the year would require in terms of sales and cost-control. It helped them set goals—targets for revenue and expenses—around which to build focused strategies and monitor results in real-time. They can look several months ahead, then develop and implement a plan now that has the best potential to maximize revenue from existing and new customers in the coming months.
This is key: doing projections helps you create a plan, take actions that you can monitor and measure, and reduce variability, and increase the predictability of success. If you need to renew 30% of prior year customers and bring in two new orders totaling $20K in order to make your desired revenue goal for November, the sooner you know that and the more time you have to make that happen the more likely you are to succeed.
While the outcomes can’t be guaranteed, without a plan failure is inevitable. With a plan, you can do everything reasonable and feasible to make your financial assumptions a reality.
Building Cash Flow Scenarios
The next step is to take what you know about how your business is performing in 2020 and run scenarios for 2021 using that information and the data you have from prior years. Like my clients, there are several things that will factor into your scenarios:
Your knowledge of your industry
Understanding of your clients and their needs
Ability to position your company as a preferred solutions provider for existing and prospective clients
Capacity to be creative in attracting and retaining customers
Cost management strategies
The goal is to think about best, worst, and likely scenarios so you can do your best to anticipate what resources you will need and what actions will be required to tip the scales in favor of success.
Why Build Scenarios?
Like me and my clients, you have people counting on you. Your family, the employees, and contractors you hire, the vendors you buy from, the clients you serve. That’s a lot of responsibility. Even for those small businesses that have seen an increased demand for their goods and services during this time, success is not a forgone conclusion. Increased revenue doesn’t automatically and inevitably lead to increased profitability. While we can’t predict the future, we can look at what we know, make educated assumptions, think through possible futures, and use that information to plan, act, evaluate, reorient, and repeat on an ongoing basis.
Here’s the thing: knowing what the future could look like gives us the opportunity to think through what we can do to try and create the future we want. That’s the art of business management and strategy—planning and execution to create desired financial results. It’s time to practice your futurism skills.
Cash Flow Scenario Examples
Worst case: Let’s say you have seen a drop in revenue this year. Perhaps your worst-case scenario is another drop of comparable size in year over year revenue for 2021. Or a delayed recovery with revenue returning to pre-COVID levels in Q3 or Q4 of 2021. Maybe revenue stays steady but your cost of raw materials or shipping costs increase. The idea is to look at What if X happens and think through what impact it may have on the bottom line and what sources of capital (savings, lines of credit, loans, grants, investors) might you have or need to make it through times when net revenue is down.
Best case: This is your most optimistic outlook for 2021. Perhaps expenses remain relatively constant with no new cuts needed and revenue declines stop or revenue starts to slowly rise. Or you may have entered a new market or launched a new product/service at the end of 2020 that helps accelerate revenue growth in 2021. It might be that your current customers have decided to invest in things that will accelerate their own growth and are ready to buy again. This scenario looks at how things might improve—return to pre-COVID levels or even better—and the reasons you believe that can happen. It may also prompt you to think about how you will eventually reinvest your profits to maintain growth and increase profitability moving forward.
Likely case: Somewhere between the best case and the worst case is what is likely to happen. It is neither overly optimistic nor conservative. It blends the most likely revenue, expense, and access to capital scenarios.
You may have several best, worst, and likely scenarios. This is when it pays to work with a professional who can help you build spreadsheets that allow you to change and test different variables with minimal inputs and edits, and where getting down to granular levels of detail can really matter.
In the end, the cash flow scenarios you build will give an important tool for making immediate decisions regarding strategy and tactics, as well as a way to monitor those assumptions and compare them to actuals over time.
Remember, what we are talking about is financial planning, not accounting. You may use some data and reports from your accounting system to inform this work. However, the bulk of this knowledge will come from you and what you know about your business and your industry. Businesses coaches and strategic business advisors can help you tap into and unlock this way of thinking.
