Imagine being a Coca-Cola Company executive in 1985. You’ve just finished testing a new product shown by studies to be preferred by almost 200,000 customers. You’re ready to launch and projecting huge sales. Then you launch New Coke.
We all know how that story ends.
The outrage and abrupt drop in sales prompted Coca-Cola to retire New Coke and return to their classic formula after only 79 days on the market. But Coke was already a well established brand by 1985 and, despite what must have been three dismal months, they made a remarkable recovery.
As a self-employed person, would you be able to bounce back so readily, if a risky move turns sour or unexpected expenditures arise?
QuickBooks Self-Employed want to help you prepare for that scary moment in any entrepreneur’s life, when your cash flow dips into the red.
What is cash flow?
At its most basic, cash flow is the money coming in (inflow) and the money going out (outflow) of your business.
Cash inflow includes things like sales income, loans, and available interest. Essentially, it includes any money or assets currently available to your business.
Cash outflow might include purchases of goods for resale, employee wages, or rent. Depending on the expense, these might be one-off payments or they might be instalments paid out at regular intervals.
When your cash inflows beat out your outflows, you’re said to have positive cash flow. When the inverse is true, you have negative cash flow. While the dangers of a negative cash flow are easy to understand, because they indicate debt, a persistent positive cash flow may also indicate problems–it could point to lost sales due to stock shortages, for example.
A healthy cash flow carefully balances your inflows and outflows so that one does not greatly exceed the other.
The most common problem people experience is needing funds to pay employees, purchase stock, or pay for equipment before payment is received–sometimes even before a client is invoiced!
Your cash flow could be affected by things like numerous bills arriving simultaneously or unexpected repair costs. You might also experience a dip in sales due to world events, like a spike in the cost of natural gas, or perhaps a new competitor that enters your field.
Unfortunately, cash flow imbalances are not always under your control. The best you can do is plan ahead, so that any seasons of surplus you experience can offset months of drought.
Cash Flow Forecast
A cash flow forecast helps you predict turbulent waters that you might soon be treading, by helping you budget for lean periods during months of excess. A cash flow forecast can be drawn up monthly or even weekly if needed.
Your forecast should be divided into three main sections: operations, investing, and finance.
- Operations details all costs and earnings associated with your main business, whether that is selling a product or performing a service.
- Investing lists any assets that you have bought or sold, such as property and equipment costs. Don’t be alarmed if this category is usually in the red!
- Finance lists any business activities involving debt, borrowing money, and paying dividends.
In each category, record cash inflows as positive numbers and cash outflows as negative.
You should also have two columns in each category which allow you to compare projected inflows/outflows against actual inflows/outflows. Noticing discrepancies between your forecast and the actual figures will allow you to identify and address potential cash flow problems.
Don’t start sweating bullets if this process sounds daunting. QuickBooks Self-Employed offers budgeting software to help simplify keeping track of your accounts, and will do all of the number crunching for you.
Dealing with shortages
Even businesses expecting to turn a profit during their fiscal year can fail if they run out of money and are unable to pay their bills. Being able to forecast shortages is great, but how do you deal with those challenging months?
There are a few strategies you can try, but the most effective is to plan ahead through your cash flow forecast. Ideally, you will be able to equip yourself with a cash reserve and overdraft facilities to help you through periods of unexpected shortfalls.
If your problem is lack of sales, you might also consider chasing down late payments or offering incentives, such as discounts, to attract more customers.
If, on the other hand, your cash flow is suffering because you’re unable to meet the demands of your clients, it may be time to consider expanding! Hiring additional staff or purchasing new equipment to help you meet demands are all investments that will pay out in the long run if you’re struggling to accomplish larger contracts.
When unexpected costs crop up, you may have to take out a loan, but–be warned–most lenders will also ask to see a cash flow forecast before any money changes hands.
Visit our self-employed page for more helpful resources.