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Cash-flow modeling helps your business avoid flying blind

Rochester Business Journal
December 13, 2013

For businesses interested in positioning themselves to survive challenging times and capitalize on periods of opportunity, information is essential. More specifically, having a clear picture of cyclicality and cash on hand, which can be accomplished through cash-flow modeling, is an invaluable tool for strategic planning.
Cash-flow modeling can provide your business with the data you need to formulate cash-flow projections and tailor strategic plans that help predict future profits, borrowing needs, capital expenditures and labor requirements. It also helps lenders and investors determine your creditworthiness and relative value in the marketplace.

The value of cash-flow modeling
Cash-flow modeling generally improves a company's long-term viability and its ability to deploy capital effectively to meet business needs. In addition, by compiling, presenting and analyzing data in a disciplined, replicable way, cash-flow modeling presents an opportunity to see patterns you intuitively know are there but otherwise could not substantiate.
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 reveals patterns of who pays when, which may suggest alternative methods that could be beneficial to your business performance. Using this data, your business can determine if customers are paying the way you want them to and can consider whether offering a discount for faster payment might make sense in certain cases.
On the outbound side, cash-flow modeling can help identify 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 for 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 on 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 and find a solution.
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, as the owner or CEO you should at a minimum review and understand the results of all cash-flow modeling exercises. It demonstrates competence and financial savvy-that you understand the role that modeling plays in the health of the business-and it can go a long way toward securing an investment, new credit facility or extension of an existing credit facility.

Four types of cash-flow models

There are four types of cash-flow models, each fine-tuned to focus on a different aspect of how money comes into and goes out of your business. However, each model essentially 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, a valuation model that essentially tracks the internal rate of return of a business or a specific project within the business.
  • Cash-flow sensitivity analysis, which is used to forecast changes in receipts and disbursements and the effects those changes would have on your cash requirements.
  • Free cash-flow valuation, a method of valuing a company strictly on the basis of its free cash flow, as the name implies. Free cash flow is the cash available to a business's owners and/or creditors after all operating expenses, interest and principal payments, and necessary investments in working and fixed capital have been made.
  • Cash-flow gap analysis, a model that analyzes the gap between payment for the resources your business needs and payments received for the goods or services produced with those resources.

Maximize the value of your efforts
The frequency of cash-flow modeling and analysis should be determined, at least in part, by your business's degree of volatility. 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 tool and financial tool. If done well, it allows you and your financial team to present data in a consistent, replicable, repeatable format that can be analyzed to produce efficiencies and deliver strategic value.

James Barger is president of KeyBank's Rochester Market. He can be reached at (585) 238-4121 or

12/13/13 (c) 2013 Rochester Business Journal. To obtain permission to reprint this article, call 585-546-8303 or email

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