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In times of high uncertainty, it is even more critical for business leaders to have a firm handle on their company’s cash position. There is no better management tool for this task than the 13-week cash forecast.
Traditional financial statements forecasts are prepared monthly and presented on an accrual basis. Relying on them to manage cash is a recipe for financial disaster. Take the following hypothetical consumer goods company forecasted income statement as an example.
On the surface, this looks like a healthy company that is expected to generate positive cash flow. During the quarter, the company is expected to generate $4.4 million of sales, $244K of EBITDA, and $172K of Net Income.
But these numbers don’t tell the full story. They come from an income statement, which, as we know, is presented using accrual accounting and prepared monthly. The numbers don’t capture the timing difference between when transactions are recognized for accrual accounting versus when cash flows actually occur (e.g., working capital items like accounts receivable, inventory, and accounts payable). They don’t capture the changes in cash related to non-income statement items like debt or capital expenditures. Lastly, they don’t capture the nuances of how cash inflows and outflows ebb and flow on a week-to-week basis over the course of a month or quarter.
The 13-week cash forecast, on the other hand, is prepared weekly and presented on a cash basis. A 13-week cash forecast projects all sources and uses of cash at the customer and vendor level, includes the total impact to cash from the income statement, working capital, debt, and capital expenditures, and provides visibility into the weekly nuances of cash flow timing.
Elaborating on our previous example, below is an example of what the 13-week cash forecast might look like for the aforementioned 3-month income statement forecast.
The 13-week cash forecast makes several things apparent that were not readily available from the income statement alone. First, the same company that is expected to generate positive net income of $172K over the next 3-months is actually projected to lose $106K of cash over the same period! (This is mainly due to $248K of projected principal payments related to debt and $30K of projected capital expenditures that are not captured in the income statement.) Secondly, and maybe more alarming, the company’s revolver balance is supposed to peak at $1.7 million in week 5, reducing the company’s borrowing base availability to a mere $14K! This should be a huge red flag for the company. A small miscalculation in the forecast (e.g., a shortfall in expected sales, a customer paying late, or a variance in freight costs) could cause the company to run out of liquidity in week 5.
The aforementioned example is simplified for discussion purposes, but the lessons are clear. Implemented and managed properly, the 13-week cash forecast provides management with a newfound level of financial visibility and access to real-time information to make critical business decisions. In my 12+ years of experience in private equity, investment banking, and financial advisory, there is no better tool for managing cash than the 13-week cash forecast.
In practice implementing a 13-week cash forecast report can be a heavy lift, but the payoff for any company that does is enormous. The benefits are as helpful for small companies as large companies, and for distressed companies as healthy companies. Simply going through the process of identifying and estimating the various weekly cash inflows and outflows forces management to understand the details of their business at a much more granular level. It can uncover insights that can lead management to improve cash collections, identify opportunities to reduce or defer costs, and to make critical business, financing, and investment decisions. It instills a financial discipline in decision making and a culture that is focused on cash. Importantly, it can help companies identify problems (e.g., running out of cash) before they occur, so that management has time to act and plan accordingly.
With that in mind, below are 10 useful tips and best practices to keep in mind as you go through the development and implementation process of the 13-week cash forecast.
Overview
1. Developing and managing the 13-week cash forecast requires a person with a firm understanding of accounting, finance, and business. Typically, the forecast is designed and maintained by the CFO, controller, or an outside consultant that specializes in cash management.
2. 13-week cash flow forecasting should be inherently conservative. While many businesses shoot for the moon in their budget, there is no benefit to shooting for the moon in the cash flow. Running out of cash because there is no conservatism is a common mistake.
Format
3. The 13-week cash forecast should mirror a similar format as the company’s income statement. This allows for easy comparison to the existing financial reporting (e.g., monthly financials and budget) and a sense of familiarity for use amongst management, board members, lenders, and other stakeholders.
4. Operating disbursements should be grouped into functional categories (e.g., COGS, fulfillment, marketing, and overhead) with fixed and variable costs separated. This allows one to intuitively assess how various sales forecast assumptions impact direct and indirect expenses differently. It also sheds light on what costs can be better managed or reduced to improve cash flow.
5. Non-Operating Disbursements (e.g., financing and investment-related expenses) should be tracked separately from Operating Cash Flow. This allows one to quickly identify how much cash the business is generating before financing and investment decisions.
6. A summary of the weekly projected net cash flows’ impact on ending book cash and the revolver balance (if applicable) should be included at the bottom of the report in the Liquidity section. This section quickly illuminates any peaks and valleys in cash and borrowing base availability in the upcoming weeks based on the current forecast assumptions.
Inputs
7. The manager of the cash forecast should identify what information is available to update the cash forecast and develop a system for incorporating this info into the cash forecast. Example inputs may include the accounts receivable aging (for cash receipts) and the accounts payable aging (for cash disbursements).
8. Key senior executives (e.g., CEO, COO, CMO) should be involved in the forecast process and provide the manager of the cash forecast with weekly updates on significant business decisions, business trends, and other assumptions that impact cash. Examples may include updates to sales forecasts, open purchase orders, and staffing assumptions.
Other
9. Many 13-week cash forecast reports include supporting schedules and are typically no more than 2-4 pages. A standard 13-week cash forecast report will consist of a summary of qualitative assumptions, the underlying 13-week cash forecast, a variance report summarizing the changes since the last report, and a summary of approved vendor disbursements for week 1.
10. A useful sanity check on the overall accuracy of the cash forecast can be to look backward to see how much money the company collected and what the company spent money on over the last 13 weeks. Bank reports, the check registry, and vendor disbursements reports can be helpful with this. Of course, seasonality and new developments can render historical data (especially sales and variable cost data) mostly useless, and therefore should be used cautiously.
The partner at Cronkhite Capital has over 12 years of experience investing in, operating, and advising small to medium-sized businesses across industries. If you are interested in learning about how Cronkhite Capital can help your company, please reach out directly to Ryan Hammon. Email - rhammon@cronkhitecapital.com Phone - (415) 847-8103.
