• A cash flow forecast is a vital tool to predict any cash flow shortfalls.
• They help you mitigate risks and avert a crisis by raising funds through short-term bank loans, asset sales, refinancing and equity financing.
• You can also consider borrowing from friends and family, using your own funds or getting investors on board.​

Wouldn’t it be nice to know what the future holds? To know how much profit you’re going to make, and knowing you have the cash flow to support it. That’s every business owner’s dream.

But reality is often far different. Cash tends to ebb and flow. Some months there is plenty of money, or perhaps enough money, whilst other months it’s a real struggle to pay the bills. Then there’s the dreaded quarterly BAS bill which always seems to be bigger than Ben Hur that’s usually due, inconveniently, in a month of slow receipts or high expenses.

Cash flow shortfalls are stressful times that are best avoided. So, how can you avoid them? Whilst you may not be able to avoid them completely, by setting in place budgets and projections, you’ll have a fair idea of when you’re going to have a cash flow challenge.

What is a budget?

Before delving further into this, let’s clarify the difference between a budget and a cash flow forecast. A budget is a summary of income and expenses based on the profit and loss statement. If you invoice clients or customers and they pay you later, you have income but no money in your bank account. The budget will show the income from the invoices you expect to raise each month. It will ignore whether you get paid in that month or later.

Similarly, the budget shows business expenses when you receive the invoices and not necessarily when you may pay the bill. The budget is designed to set your overall financial goals for revenue and profit.

What is a cash flow forecast?

Cash flow forecasts on the other hand look at the same information that is in the budget but reallocates the income to when you expect to receive payment from your clients or customers. It also reallocates the expenses to when you expect to pay them.

For example, with your expenses, there will be timing differences for payment of PAYG withholding, superannuation and GST. These will have a big impact on the cash flow forecast, particularly if you’re lodging and paying BAS on a quarterly basis.

Furthermore, a budget may include insurance split across the twelve months of the year, but you may pay the premium annually in one lump sum. Another example are power bills, where the budget may have a figure for each month, but you pay the bill quarterly.

The cash flow forecast has a few extra lines that aren’t in the budget. It also shows other payments that aren’t reflected in the profit and loss. For example, hire purchase payments, the principal component of loan repayments, equipment, vehicles and other asset purchases, investments or transfer of funds into and out of the business from personal bank accounts.

The cash flow forecast encompasses every receipt and every payment that you expect to go through in the business. The net result is either surplus cash or a deficit or shortfall. Once you’ve created your budget and used it to create the cash flow forecast, you have a clearer picture of your funding requirements for the business.

Business growth: payment delays and rising costs

When a business is growing, there is a delay between payment of expenses including wages and the receipt of income from the invoices for the work done. If you’re a product-based business, there will often be a significant timing difference from when you buy your products to when you ultimately sell them and get paid.

The quicker the business is growing, the bigger the cash flow crisis that will arise. Not having a large enough buffer of cash to cover your expansion will lead to cash flow shortfalls. The final step in the cash flow forecast is to add your starting bank balance and surplus cash each month or subtract any shortfall to determine the expected bank balance at the end of each month.

How to fund a cash flow shortfall

Having armed yourself with this information, it’s time to consider how you’re going to fund the shortfall, if you’ve identified that you have some months of a negative cash balance.

If the shortfall is only one month and the following month it’s back on track again, you may be able to handle that. Look for ways to increase cash receipts in that month either by increasing sales in the months leading up to that bad month, or by seeking early payment on some invoices, or alternatively, by arranging a delayed payment with your suppliers for that month.

If the shortfall is over a longer duration, more serious consideration needs to be given to how to fund the business.

1. Using personal funds

This is by far the easiest option for funding, if you have the financial resources. The benefit of this is you don’t have to go through any application process. Given that you know your business, and you’ve prepared the budget and cash flow projection, you would know how long you’d need to lend money to the business and how quickly you would be able to repay yourself.

2. Borrowing from friends or family

It’s not the easiest thing for many people to ask for money from friends and family, but if they believe in what you’re doing, want to support you and have surplus funds available, this is an option to consider.

Make sure that you draw up a loan agreement. It needs to specify the interest rate that will be paid, the time period for the loan and when you will repay the loan, whether in full or in monthly repayments. A documented agreement is imperative to avoid the relationships turning sour when the expectations of you and your lender are different.

3. Short-term business loans

There is a plethora of new short-term loan solutions available for businesses. Many will approve loans within a very short space of time. Some lend against the invoices you’ve issued; some lend against the business itself and some will require security.

Interest rates on short-term loans tend to be quite high due to the unsecured nature of the loans provided. If you’re considering this type of facility, make sure you understand what your overall commitment will be and calculate the interest you’ll be paying for the loan.

4. Bank loans or overdraft facility

A bank loan or overdraft facility may be ideal for you, but you may need to provide bricks and mortar security to get this. You will need to go through a rigorous application process.

This is where your budget and cash flow projection will come in handy as the bank will need to see these to assess your application. Your bank will be looking for how you can show your ability to repay the loan through your budget and cash flow projections.

But beware the impact of the Banking Royal Commission, which may make it harder  for small businesses to get finance. 

5. Invite an equity partner to buy a stake in the business

This is not something to be done lightly, but if you’re already thinking of potentially selling some equity in the business and you’ve already been having conversations about this, accelerating the process to assist with the cash flow shortfalls may be a consideration.

However, taking on an equity partner has other consequences than just a solution to a cash flow challenge. This is a viable option only if you were planning on it already as part of your business growth strategy.

6. Sale of business assets

Another option is to sell assets that aren’t being utilised or aren’t necessary to the business. Their sale proceeds may be the solution you’re looking for.

This isn’t about selling assets that are fundamental to the business. But if you’ve got an extra car, for example, that used to be driven by an employee who’s left the business, it could be sold. Or, if you’ve got an expensive piece of equipment that you’ve replaced with an upgraded one, and someone else would pay you for the old equipment you’re no longer using. There may be tax consequences to consider, so seek advice from your accountant before selling any assets.

7. Sale of personal assets

It’s never ideal to sell assets, but sometimes in order to fund the business, you may choose to do so. I know owners who have sold their business premises, moved to rented premises and then used the funds from the sale to fund the business growth. There are tax and other matters to be considered and the sale needs to be part of a bigger overall financial plan and based on advice from a financial planner.

8. Refinance existing facilities with an increase to cover business requirements

Rather than selling assets, another alternative is to increase the borrowing against assets if you have equity in the assets and sufficient income to service the increased borrowing. Your financial institution will require your budgets and cash flow projections and a swag of other information to consider your application.

In summary

Bank funding may take several months from application to approval. Knowing when to expect cash flow challenges gives you the crucial advance notice to consider your funding options, most of which require time from decision to cash in your bank account.

By creating a budget and cash flow forecast, you can avoid a cash flow disaster by acting well in advance to mitigate the risk and deal with the crisis before it happens.