For businesses interested in positioning themselves to survive challenging times and capitalize on periods of opportunity, information is essential. More specifically, a clear picture of cyclicality and cash on hand, which can be accomplished through cash-flow modeling, is a valuable tool for strategic planning.
Cash-flow modeling can give you the data you need to project cash flow and tailor strategies that help predict profits, borrowing needs, capital expenditures and labor requirements. It also helps lenders and investors determine your creditworthiness and relative value in the marketplace.
Why cash-flow modeling?
Cash-flow modeling and analysis improves a company's long-term viability and ability to use capital more effectively to meet business needs. In addition, by compiling, presenting and analyzing data in a disciplined way that can be replicated, cash-flow modeling reveals patterns that your gut knows are there but otherwise can't be substantiated.
The information generated by cash-flow modeling can be very useful in other ways as well. On the inbound cash-flow side, the data identifies gaps and correlations between invoicing and payment times. It provides patterns of who pays when, which may suggest alternative methods that could benefit your business. Using this data, your business can determine if customers are paying the way you want them to and consider whether offering a discount could entice quicker payments.
On the outbound side, cash-flow modeling can find ways to simplify accounts payable and possibly save money in the process. For example, setting up automatic debits for recurring payments such as utility bills eliminates processing and mailing costs and potential late fees from checks that don't arrive on time. It helps you spot and take advantage of discounts offered by your vendors for paying early.
A cash-flow model also functions as a reality check for how well your business is performing. If forecasts account for timely payments but you're constantly getting hit with late fees, why is that happening? Going back through the data in cash-flow models helps pinpoint the source of the problem.
As companies grow, the responsibility for compiling and reviewing this data often falls to the accounting department or chief financial officer. However, at every stage of your company's growth cycle, the owner and CEO should at least review and understand the results of all cash-flow modeling exercises. It demonstrates competency and financial savvy-that you understand the role modeling plays in the health of the business-and it can go a long way toward securing an investment and a new or extended credit facility.
Types of models
There are four types of cash-flow models, each fine-tuned to a different aspect of the flow of money in and out of your business. Each model, however, looks at the same sets of raw data. The important thing is that you establish benchmarks, be consistent and stay on top of the process.
Simplified cash-flow return on investment (CFROI) is a valuation model that tracks the internal rate of return of a business or a specific project within the business.
Cash-flow sensitivity analysis is used to forecast changes in receipts and disbursements and the effects those changes would have on your cash requirements.
Free cash-flow valuation values a company strictly on the basis of its free cash-flow, as the name implies. This is the cash available to a business' owners and creditors after all operating expenses, interest, principal payments and investments in working and fixed capital have been made.
Cash-flow gap analysis looks at the gap between payment for the resources your business needs and payments received for the goods or services produced with those resources.
How frequently you conduct cash-flow modeling and analysis should be determined, at least in part, by the volatility of the business you're in. If the business is highly cyclical or volatile, conduct the exercise at least monthly. Businesses with a little more stability may be able to get by with a quarterly exercise.
The most important takeaway on cash-flow modeling and analysis for business owners is that it points out opportunities for change. It is equal parts management and financial tool. If you and your financial team do it in a consistent and replicable way, you can analyze it to boost efficiencies, delivering products and services in a way that fits your strategy.
James Barger is president of KeyBank's Rochester Market. He may be reached by phone at 238-4121 or email at email@example.com.
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