Got your Financial Forecast? Don’t Forget your Cash Forecast.

As businesses forecast their financial future, most focus primarily on revenues and profitability.  Frequently, those businesses forget or overlook that in many cases cash flow does not equal profitability.  This is evidenced by all the CEOs asking us the question of why cash balances in the bank aren’t following what’s happening on their P&L.  Businesses must keep in mind some of these differences as they forecast their performance, otherwise, they may be painfully surprised when it could all have been avoided.

The insight CEOs must either learn or remember is that there are a number of business activities that impact cash but not profitability, or in other words, their income statement.  One easily understood example is a business with inventory.  As an example, if a business sells a product with great margins and shows a profit on the P&L, but they’ve recently acquired a lot more inventory, all the cash coming from profitable operations will be used up.  This circumstance frequently leads some CEOs to ask us where their cash has gone.

But inventory fluctuations are only one item that drives differences between cash and profitability.  Other items can include:

  • the timing between receipt of vendor invoices and the timing of when they’re actually paid
  • the timing between your sending a customer invoice and when they pay
  • investments in equipment
  • loan payments

A financial forecast then cannot begin and end with a profit & loss statement.  The forecast process must continue by considering all the business activities that are not reflected in their entirety on a P&L, of which the examples above are a few.  A proper cash forecast will start with an income statement, then simply include the cash required for these other items.  Only then will you understand how cash will be generated or consumed in your business.  Here is one simple example of how to construct it from Investopedia.

A clearly explained document with detailed differences between your P&L and your cash flow is one fundamental requirement we recommend all CEOs ask from their CFOs.  If they’re unable to, perhaps it’s time to consider upgrading your financial talent on the team.