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Following on from our last article of 27 April 2020 on cash flow considerations, we now outline in this article the “must-have” information required to prepare a Cash flow Forecast, an item which is always asked for by potential lenders and which causes the most headaches for businesses to prepare.
The importance of a cash flow forecast cannot be overstated, as it indicates whether the business has seriously looked at its cash flow needs logically and systematically and has built in factors to take account of uncertainty, so crucial in the volatile climate that exists currently, where future demand is so unpredictable.
In our experience the information listed below will enable a skilful preparer, either in-house or with the help of an external accountant, to put together a cash flow forecast that would satisfy a lender and its underwriters (it is assumed that it will form part of a properly put together pack that facilitates a lender to make a complete assessment without undue reference back to the company):
1. Monthly Management Accounts
As a minimum, you will need to prepare management accounts for the previous 12 months. Management accounts provide the starting blocks to preparing a cash flow forecast (“hindsight is the best predictor”). While we believe that it won’t be business as usual (as we discussed in detail in our article on the 27 April 2020 Embracing change in your cash flow forecast) we still feel that there are many factors included in your historical data will still be relevant into the future.
The importance of monthly management accounts is that they can be used as a tool to enable one to analyse different trends within a business. The analysis will, in turn, allow one to determine which factors (both internal and external) affect the profitability of a business. To ensure that this tool can be used effectively, thought should be given to the business’s chart of accounts.
Furthermore, one must ensure that all transactions are classified and posted to the correct account headings.
2. Costing Model
A costing model provides a detailed calculation of a business’s gross profit margin, the main driver to a successful and sustainable business, breaking it down over different products or services. It is a major component of preparing a cash flow forecast. Due to likely changed supply chains Post Covid-19 there may be some items where future margins on some items erode beyond commercially acceptable levels, and these need to be identified now.
For example, if your business imported goods you may face several challenges in securing your supply post-Covid-19. There is a strong possibility that the ports may experience congestion and you could face significant backlogs in production/supply of goods you require to import from various geographies. As a result, you could find yourself in a situation whereby you are unable to secure a constant supply of goods (raw material, consumables and finished goods). This could have a significant impact on your supply chain management and that may require significant changes such as sourcing the goods locally.
It is therefore important to take the time to ensure that the principles applied in preparing this model applies to a specific industry and to include all the factors that are relevant in determining your business’s gross profit margin.
3. Debtors and Creditors Ageing
It is important to ensure that your business’s trade debtors and trade creditors ageing reports are up to date as these provide the necessary detail to understanding the timing of your business’scash inflows and outflows.
Such exercise ensures that:
Customer receipts are allocated to the correct sales invoices and
Supplier payment is allocated to the correct supplier invoice
Other important controls include ensuring that supplier and bank reconciliations are prepared and reviewed monthly.
4. Management Discussions
To ensure the cash flow statement has integrity you must have discussions with all key management personnel within the business to discuss the likely adverse changes that Covid-19 will have on the business environment.
These discussions will ensure that key members of your business agree with the changes that potentially need to be implemented as a result of Covid-19 which in turn will ensure that a seamless approach is followed when implementing the action plan reflected in the cash flow forecast. (Details regarding these factors are discussed in our article on the 27 April 2020 Embracing change in your cash flow forecast)
The management discussions are a “planning phase” and provide a clear idea of what assumptions one will need to make and incorporate into the cash flow forecast.
The items discussed above are examples of information one will be required to prepare before being able to start a cash flow forecast.
By paying careful consideration and attention when preparing these items, one ensures that a logical and thoughtful cash flow forecast is prepared in a timely and cost-effective manner. We recommend that the requisite time and attention are expended to collate and prepare the above information to prepare a cash flow forecast based on accurate historical information.
From this, clear ideas will be derived that will, in turn, provide for a high degree of credibility to a reviewer.
This, the latest in a series of articles focusing on the importance of cash flow, provides you with the factors to consider while preparing your cash flow forecasts. It is safe to say that it is not business as usual and your cashflow forecasts need to be revisited and prepared accordingly. As a business owner, you and your fellow board members need to try and embrace the change that is coming.
We have divided the cashflow forecast into 5 major categories.
As a starting point in any cash flow forecast, you need to understand what your cash ‘inflows’ are likely to be.
Firstly, you need to focus on your cur rent trade debtors and assess their collectability.
This is the time to start the discussions with your debtors to understand when they will be able to pay you and if they cannot pay on time, what plans can be put into place. This will allow you to understand what effect it will have on your debtor days ratio and ultimately your working capital cycle.
Secondly, you will need to analyse your customer base. Please see below a few examples of the factors you will need to consider:
How many customers will I retain post lockdown and how much business will they still require?
At what rate will you be able to bring in new business?
Thirdly, you need to consider diversifying your income if possible, to adapt to the changes that COVID-19 will bring to your business environment.
Once you understand your cash ‘inflows’ you can start forecasting your supplier payments. Should there be a situation whereby you will not be able to pay all your suppliers as they become due, it is important to be proactive and communicate with them. Most suppliers will feel more at ease when they are updated on your payment plan. Silence will give them unnecessary concerns.
Post-Covid 19 you will also need to consider the changes to sourcing your products, and for manufacturing businesses, how your supply chain management will be affected. These will ultimately affect your costings. So, it is important to revisit your costing model and update it with the necessary changes.
This is an extremely important exercise and will be a defining factor in determining your working capital cycle.
3. OPERATING EXPENSES
Now is the time to also perform an analysis of your operating overheads to determine what costs are necessary. For services/expenses that are necessary for your business, you need to determine if a better solution is available in the market place.
You will need to consider if your current infrastructure will accommodate changes to the business environment. Some considerations have been listed below:
Are you set up to work remotely? (You may need to replace desktops with laptop computers)
Will your business post lockdown meet social distancing guidelines? (For a manufacturing business you may need to consider automated aspects of your production cycle to meet the guidelines)
This may require an initial capital outlay which could have a material effect on your cash flow forecast and require financing.
This process, just like suppliers discussed in point 2, needs to be matched with your forecasted sales revenues. This will enable you to ensure that your business is sustainable into the future.
4. INTERNAL CONTROL ANALYSIS
To embrace the changes inevitably brought about by a changing marketplace, it is important to revisit your internal controls within your business built up over time, to ensure they continue to be relevant. This will provide you with an action plan to implement the assumptions you have incorporated into your cash flow forecast.
Internal controls, if implemented correctly, will assist in the elimination of unnecessary bureaucracy or conversely adding more controls to improve productivity, a key component in being successful in the future.
This will ultimately lead to maximising/maintaining the level of profitability in your organisation. We recommend that an independent party performs the internal control review as it will provide an outside perspective of your business. At this time, there is a need for “thinking outside of the box,” which will be required when embracing change.
5. LOAN & HMRC PAYMENTS
It is important to include in your cash flow forecast deferrals of any loan or HMRC payments as this can assist with your short term cashflow requirements.
Regarding any bank loans, it is important to communicate with the bank in advance if you forecast that you will experience any cash flow difficulties. It is recommended that preventative measures are put in place before any payment(s) become due.
If you are deferring any payment to HMRC you need to ensure that you comply with the necessary legislation to be able to do so.
In much the same way as it is said that tax deferred is tax saved, so it is with these payments that can reasonably be deferred or better phased, gives a business the greater chance of survival. We believe that the items discussed above outline the contributing factors that will have a significant impact when preparing or revising your cashflow forecast, which should be done on a rolling 13-week basis.
In conclusion, the changes in the business environment that are coming will mean that your cash flow forecast will assume critical importance by demonstrating both internally in the business itself and externally to those outside it, that the business is properly managed and has a full understanding of its funding needs going forwards.
This article provides general advice and does not cover any specific market sector. Furthermore, this article does not include all the factors you need to take into consideration when preparing your cash flow forecast.
The COVID-19 virus will have a serious financial impact on the economy. There is still a lot of uncertainty pertaining to the extent that GDP will contract in the UK. The contraction of the economy is directly proportional to persistence of the outbreak.
The UK will enter a deep recession with GDP expected to contract by at least around 5% in 2020 and only have gradual growth in 2021.
From our perspective we agree the economy will go into a deep recession but that it is very difficult to quantify and predict the extent of this. We feel that we are in unchartered territory and there is no comparable benchmark to really understand its effect.
So, in our opinion the best thing is to position your business in the best possible way to fight any adversity it may face both in the short and medium term.
To combat this governments around the world have approved massive stimulus packages. Most notably the US has approved a stimulus package of $2tn.
The UK has announced a GBP330bn package of support for businesses. This is on top of the previously announced GBP30bn support package.
Cashflow projections are vital to your business in these uncertain times. You need to understand what are the cashflow requirements of your business in order to ensure its survival into the future.
IN A FINANCIAL CRISIS SOMETIMES, SURVIVAL WILL EQUATE TO FUTURE GROWTH
The financial crisis could continue for a prolonged period, so we recommend that you start with a weekly cashflow forecast for the next few weeks especially during the lockdown period and thereafter prepare a 12-month cashflow forecast.
It is imperative to include a breakeven/“stress test” analysis in the cashflow forecast of your business by looking at different scenario that can come about from this crisis.
Some of the advantages of preparing a cashflow projection:
A short term weekly cashflow projection will allow you to understand your immediate needs to get through this trying period.
As a minimum, a cashflow projection will allow you to understand if a capital injection is required and if so, how much and when you need to obtain the funding?
Provide you with an advantage in obtaining a package of support for businesses offered by the UK government.
It allows you to consider and plan how to implement efficiencies in your business.
If your projection indicates that your business will have a cashflow shortage you can assess whether to obtain Debt or Equity Finance.
Please see below an illustrative example of our discussion:
FIGURE 1. Please note:the above graph is used to best illustrate the movement of cashflows and revenue within businesses during the lock down period. This doesn’t consider any market sector but rather considers the general economy. The above graph assumes that the lockdown period will not be extended past May 2020.
The above graph shows the relationship between your forecasted cashflow as a percentage of your cash requirements.
We feel a lot of businesses will really feel the effect of the lock down moving into June if most of your customers have credit terms.
We wanted to illustrate that you don’t need to only understand your cashflow requirements over the lockdown period but also the impact it can have further down the line. Where the forecasted cashflow drops below 100% shows the period where funding may be required.
The graph above illustrates that you will have a cashflow shortage starting in June and you will only exit this position only in November 2020. Furthermore, the maximum actual cashflow shortfall will be 50% of your cashflow requirement and this will be experienced from July and August 2020.
Incorporated in the above graph is also the relationship between your revenue as a percentage of your cashflow requirements. Again, we wanted to illustrate the effect that this lockdown can have on your revenue.
We do not believe that it is practical to assume that your business will be making the same turnover immediately after the lock down period ends. A detailed forecast of your revenue needs to be considered in order to understand your business’s breakeven point and at which point it will become profitable again. Breakeven is illustrated in the graph at the point that the “revenue” and “cash requirement” lines cross.