80% of Businesses Fail Due To a Lack of Cash. Here are 4 Reasons Why Cash Flow Forecasting Is So Important
Cashflow forecasting helps businesses predict when issues may arise and allows them to take action proactively to avoid cash flow gaps.
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You might have heard that the biggest cause of business failures is cash flow issues, but to what extent is the severity of this widespread problem? To put things into perspective, more than 80% of business failures are due to a lack of cash, 20% of small businesses fail within a year, and half fail within five years.
But it doesn't have to be that way. In fact, many businesses can avoid cash flow problems with proper cash flow forecasting. Cashflow forecasting helps businesses predict when issues may arise and allows them to take action proactively to avoid cash flow gaps.
That said, many businesses already operate at max bandwidth, and cash flow forecasting isn't on business owners' minds. It's usually already too late when business owners are hit with a financial setback and realize they don't have enough cash to cover it.
Many business owners don't realize that the scope of benefits that derives from good cash flow forecasting goes light years beyond helping the business plan its operation. If you are still thinking about why you should bother with it, here are a few reasons why you should do cash flow forecasting:
1. It helps businesses avoid cash flow gaps
This is the most straightforward and important reason why cash flow forecasting is crucial.
Here's a scenario for you: John's client promised the payment would be deposited by today, but there has been a mix-up, and the bank said John wouldn't get the money until next week. John is expected to pay his vendors tomorrow, but without receiving the payment from his client, he doesn't have enough money to pay. The cycle continues.
This is the reason many businesses fail.
A cash flow forecast helps businesses avoid this very situation. They can use a forecast to project best-case scenarios, worst-case scenarios and everything in between. They can then use that to make prudent decisions about how much money to spend, where to put it, and when to spend it.
If they think there's a chance cash may not come in the door, the business could decide to put off a big purchase. Or they could talk to vendors and get an extension on payables. Or they could offer customers a discount to pay their bills early. The forecast gives the business the knowledge they need to take action and avoid difficult cash flow situations.
2. It helps secure loans
Loans are an important part of running any business. Financing can help a business expand, improve its products and workflows, or cover operational costs in a crunch.
However, obtaining financing is easier said than done, especially for businesses with little assets or no credit history. In this case, lenders look at profitability, expenses and cash flow.
A strong cash flow forecast helps a business prove its creditworthiness to lenders. A business can use its cash flow forecast to show that it deserves a loan and is a good credit risk. Or, if your cash flow forecasting shows otherwise, maybe it's a good time for you to assess internally and improve your cash flow position before going to a lender for a loan.
3. It helps businesses make better decisions
A cash flow forecast gives a business a glimpse into the future. It helps them view when cash is coming in and going out, so they can better plan for the future and make strategic decisions that align with their budgets.
Let's say a business is considering hiring additional staff or purchasing new equipment. A business might look into how much money they have right now, thinking they could cover the extra expense. But what if the business lost a major client a week from now? Or what if sales suddenly plummeted due to competition?
These are the kind of things that your account balance can't tell you and are the exact reasons businesses need cash flow forecasting. By understanding their future cash availability, businesses can make informed decisions about when and how to invest in their growth.
4. It helps businesses set measurable goals
Leveraging cash flow forecasts can help businesses set measurable goals to improve cash flow tangibly and determine the path to better business outcomes.
If a best-case scenario forecast says you can potentially grow your business revenue by 50% by improving your operation with a new equipment purchase, you now have a benchmark number.
Or, if you plan on reducing expenses by 20% by cutting out parts of your business operation, cash flow forecasts can help you see the business and revenue impact of cutting out a project and if the financial cost reduction is in line with your decision. You can now set data-driven business goals, know what outcome to expect, and measure success.
That's two drastically different examples, but no matter what situation your business is in, cash flow forecasting can help a company set measurable goals.
Forecasting for your business is easier than you think
Here's the thing about cash flow forecasting: It's not new, but it used to be a challenging, labor-intensive, and time-consuming job that business owners would task their accountants with. The good news is that innovating technology makes cash flow forecasting easier than ever before. New tools now directly integrate with many cloud-accounting platforms that businesses use, making cash flow forecasting faster, more accurate, and sometimes even for free. Start looking for a solution that works with your accounting platform today, and see the wonders it can do for your business.