ALEX: Hey there! This is Alex, I' the VP of Client Success at Benchmark Cloud Accounting. I'm here today along with you, our wonderful audience, to learn a little bit more about cash flow forecasting and cash burn projections.
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I am happy to welcome back my friend and colleague Skip D'Orazio, and I am extremely excited to report that he's received a well deserved promotion within our organization: CFO and VP of Finance & Accounting Operations. Skip, welcome and congratulations on the new role and title!
SKIP: Thank you Alex, good to be here.
ALEX: So let's just start off with the basic definition of a cash flow forecast as stated by a wonderful resource I found online a few days ago. The definition that I read stated that "a cash flow forecast is a projection of how much money you will have in the bank after accounting for income and expenses over a given period of time. The cashflow forecast creates an estimate of your future bank balances based on the money going in and out of your business."
That seems pretty straightforward, but I feel like it doesn't really capture all the complexities that are involved in this type of forecasting and projections. Skip, in your own words can you help us understand some of the additional elements that go into a cash flow forecast?
SKIP: Sure! Well first of all, I would refer to it as a tool you would use to look at and help forecast the health of your business over a period of time. Generally this is done every couple of weeks or maybe every month on a go forward basis looking at where you are today and where you will be, and it involves making several estimates and assumptions which we can go into here in a minute.
ALEX: Ok. So that is a lot more frequent than I would have expected. As somebody who lives on the more operational side and technology side of an organization I don't dig in to the financials very frequently, except when someone like yourself provides updates to us. I didn't realize that was something you were recompiling and re-forecasting on such a regular basis. Does it shift with the age of the organization how often you're doing that kind of forecasting?
SKIP: Of course it does. A newer company, or a company that is more sensitive to cash coming in and going out is maybe going to do it as much as every week. Certainly every couple of weeks or every month is something that companies of any size will do.
ALEX: Ok. Can you explain to us what steps are involved in going through this process? I would imagine its much heavier on the front end the first time you go through this process, and then as you're refactoring week by week and month by month it becomes more of a streamlined process.
SKIP: Well let me put it this way. Because its a "look forward" on your business, its not how much cash do you have on hand today, but how much you will have 3 months from now, even 6 months from now. You are making some assumptions, and those assumptions should be based on your knowledge of the business.
So in simple terms, there are 2 components: how much money goes out and how much money comes in, and the timing of each. So you have to break down those two elements. It starts with knowing your business and your customers, and knowing when your customers are going to be billed for your goods and services.
An example: you might say 60% of our revenues are collected the following month and 40% the month after that. You will also look at, on the other hand, when cash goes out. If you're a company that buys through a supply chain, that would have different timing than if you were with a service company. You're looking at the key factors of how you spend money and how you collect it.
ALEX: Got it. So, of the things that I've had many conversations about with early-stage businesses is how based in reality do these projections need to be? You know a lot of founders compare it to kind of the "thumb in the air," right, just seeing which way the wind is blowing when they're doing some of these financial projections in the first year of their business. How do you help earlier-stage companies try to tie those two numbers that are based in some level of reality into some realistic projection?
SKIP: First of all, when you're looking forward and forecasting, you are going to make assumptions about your business. It shouldn't be "Which way is the wind blowing?", it should be based on reality and what you know about your business. To the extent that you know little about your business versus you know a lot about it because of the stage that your company is in, you will have to make a best guess. But, what you do is you come back and compare your forecast to what really happened. It's all based on your cycles of selling and paying for stuff. So one, you'll definitely want to compare your forecast to what's actually happening. Two, you're going to want to adjust your assumptions. Maybe you're collecting your receivables faster, maybe you're collecting money up front before you render a service or deliver a product. You are constantly fine-tuning your assumptions, and you're of course always comparing the end of your forecast to where you actually land and adjusting your assumptions going forward. It's a dynamic, real life tool that owners of businesses and financial experts within the business should be using very very frequently.
ALEX: Right, right. This is one of the things I always try to provide feedback on for those earlier-staged businesses and first time founders in particular, just to make sure they and their investors understand these are projections and that there are risks involved. That is one of the key things I remind them of to help make sure they are communicative with their investors and providing them updates along the way.
SKIP: Absolutely. It's a dynamic tool, Alex, and with that means you need to need to update those business assumptions as they change significantly. Obviously a first stage company is going to make a best guess, and those assumptions will be refined over time as their cycles become more mature and more predictable.
ALEX: Thanks for that, Skip. So I have two more questions that I think are relevant to this conversation. So obviously some of the services we provide as an organization are that we are providing an outsourced CFO type of role for some of our clients. As someone who is outsourced, how does that impact the projection process and how do you make sure that you're getting inputs since you aren't fully embedded within an organization to get these projections right?
SKIP: Good question. Whether you are doing this daily as a fractional CFO or every day, full time, ongoing, the method you use and the people you need to talk to wouldn't change. So you aren't doing this in a vacuum. You are understanding, first and foremost, the sales cycle and talking to the sales team. You're not only talking to them in terms of what their thinking is, you are also taking into account the historical past to in effect manage what they're saying against reality.
So example: they say we're going to close a large deal every month for the next 6 months, but you look back and see that they've been successfully closing those deals every 45 days. You will adjust going forward. Same thing for paying for goods and services. You're dealing with your own supply chain and your own payroll within your company, and you will continually tweak those assumptions to look at the ebbs and the flows. this is a tool that once you start using it, you have to adjust and you have to have involvement from almost every aspect from the company; those who are spending money and those who are generating money. The point is you can't do this in a vacuum.
ALEX: Right, yes. There is one more thing we have that I think is really relevant to discuss which is the tech and the automation. You've talked about utilizing the actual projection as a tool, but of course there are tools that support that tool! So in going through this process and seeing the industry continue to develop and leverage this technology, what tools and automation have you seen over the last few years that some of the founders and CEOs have leveraged to keep these projections accurate?
SKIP: To be quite honest it can be anywhere as simple as an excel spreadsheet, depending on the level and complexity of the company, to cash forecasting models that we at Benchmark would use. There's a range of tools out there from spreadsheets to products that you can utilize. It also depends a little bit on the complexity of the company and what the team is most comfortable using. The more complex the business and the more variables there are used in forecasting, and it would require different elements that then would lead you to use a different tool.
ALEX: So it sounds like you can start simple and as things continue to grow you may need an additional tool or management process. I think you hear that a lot from tech startups, you know? They say you. want to put a robust technology solution in place day 1 and sometimes it's just really not necessary.
SKIP: You're right, it's not necessary, but you can grow into something more complex fairly easily.
ALEX: I assume as part of your role in various organizations you have these templates you can put in place and get people lined up with as key individuals within an organization, and kind of put it in their hands to update periodically.
SKIP: Absolutely. Whichever tool you utilize is simple. The key is understanding your business and understanding the key elements of how cash is generated and how cash is spent over a period of time. that requires a little bit of collaboration within your company and a little bit of judgement in terms of applying assumptions that aren't too aggressive and aren't too conservative. That's what the process is what is important, not as much the tool.
ALEX: I think that makes a ton of sense; thank you for that. Alright! We have once again dug further into this topic than expected, so we'll go ahead and wrap up today.
Skip, once again I want to thank you so much for your time! This topic is going to be extremely beneficial as we continue to share it with our clients and prospects. For anybody who does want to learn more, you can always find us at benchmarcloudaccounting.com or bmca.us. If you'd like to reach out to me or Skip directly you can reach us at email@example.com and firstname.lastname@example.org, and of course feel free to connect with us on Linkedin. Thank you guys so much once again for your time! We will see you again soon.