Over focussing on cash flow forecasting and reporting can be dangerous

cash flow forecasting and reporting

Cash flow forecasting and reporting has become a huge trend in the accounting profession worldwide.

And there’s been a proliferation of apps that can help do exactly that for your clients. We all know that cash is king and understanding how cash flows in your clients’ businesses and helping them manage their cash flow is vital for success. 

However, an over reliance on cash flow forecasting and reporting can be dangerous. And making business decisions based solely on cash and the cash position can be detrimental to the long-term interests of any company. Yes it may sound counter-intuitive, but it is true. Let me show you with an analogy and a real life example. 

If you drive your car looking only at the fuel gauge, you will crash!

We can all agree that cash is the fuel for business.

When driving your car, having fuel and getting access to fuel are critical to the smooth running of your engine and the ability to get to where you want to go. Running out of fuel means the engine will stop and not knowing where you can get your next fill-up means you can only drive for as long as you engine has fuel. When planning a journey, you need to know roughly the distance you want to travel, how much fuel you have in your tank , whether you will need more and where you are going to get it. This process is so natural and fuel so widely available (well  until recently!), you probably don’t even know that you’re doing these automatic calculations in your head.

Keep your eyes on the road

However, if you were to drive looking at only your fuel gauge, quite simply, you would crash. When driving, you need to take into account (amongst other things): your surroundings; road conditions; the weather; risks and probabilities; signage and directions; warnings (in and outside the car); and the side of road you are driving on. When planning a journey, you need to consider many more things than just your fuel, such as: how many passengers you might have, your tire thread and pressure, oil levels, luggage and space, comfort stops etc

It’s exactly the same for business

But it goes even further!

A business can never generate operating cash without the entire business model generating sufficient operating profit. Of course, you can always shore up the cash position, in the short-term, with finance (invoice or asset financing, loans, grants etc). However, without sufficient operating profit, it’s likely the business will die …. financing will ultimately run out. [There are exceptions but these are not the norm for our small business clients.]

Looking at the entire business model

When looking at, managing or planning your business – just like driving a car – you need to look at far more than cash flow forecasting and your cash position (where it is now and where it might be in the future). You need to look at the entire business model:- how it delivers value, customers relationships, distribution channels, key activities, resources, partnerships and the associated revenue streams and costs. You need to understand how your clients turn assets into revenue, revenue into operating profit and operating profit into operating cash. We need to look at the operating environment, competition, regulations and macro-economic factors. We need to look at marketing, sales, technology operations and finance. Finally, we need to look at financing. 

Cash is just one (albeit important) element of a business. And making decisions based on cash alone, can be dangerous. This real life example will highlight the problem.

Real life example of making decisions based on cash flow alone

At a recent mastermind session we were running, an accountant came to the session with a cash issue.

They were suddenly running a deficit and looking to make savings to correct the position. An obvious and natural response. Cash flow projections had been prepared. Two members of the onshore team had been already let go and the question brought to the group was whether to put increases to the existing offshore team on hold. In isolation, based on the previous decision to let team go and taking the question on face value, the answer should have been obvious.

The accountant had significant plans for growth over the next twelve months. How was this going to be achieved without sufficient team to deliver? Well, you might think that maybe the plans were too ambitious or rich? In fact, they weren’t. When delving a little deeper, it appeared that the current cash flow issue could be blamed in part on the two team members (who had been let go) underperforming – turnaround, billings etc. And it could be assumed with current work in progress and the layoffs, the situation would self-correct quickly.

The Main Issue

However, the main issue with cash flow was really caused by the underlying business model and the significantly low revenue per employee number. When we looked into the components of that number, it turned out that real issue was that the compliance function had been completely over-engineered. Team members were wasting significant amounts of time on working papers, processes and file work they were never going to be paid for. There were also some further issues with scope creep and team dumping time.

The offshore team were being recruited as part of a plan to build the business. Had the accountant made the short-term decision to halt those plans, it would likely have had repercussions down the line. However, the most significant issue was that, left unchecked, the current business model was always going to cause cash flow issues and no amount of paring costs would solve that. In fact paring costs and team could mask a bigger issue temporarily, but exacerbate the problem long term.

Conclusion

Cash is vital for any business. And managing and reporting on cash flow is important. But relying solely on cash flow forecasting and reporting and making business decisions solely on the basis of cash may be detrimental in the long term. It’s like driving the car looking only at the fuel gauge!

About Clarity

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If you think Clarity is just a piece of software, you’re missing the point. It’s a mindset shift, a different way of doing business.

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