If you're like most small business owners, you're wearing a lot of hats. You're the CEO, CFO, marketing director, and customer service representative. And while you love your business and are passionate about it, you may be feeling a little overwhelmed. That's where a fractional CFO can help. A fractional CFO is someone who can help take some of the burden off of you so that you can focus on growing your business. They can do everything from helping with financial planning and analysis to providing marketing advice. So if you're looking for some help in growing your business, a fractional CFO may be just what you need.
As the name suggests, they help businesses manage their finances by working on a part-time or as-needed basis. And while this may seem like an unnecessary expense for small businesses just starting out, there are several reasons why hiring a fractional CFO can actually be one of the best decisions you make for your company. Here are four of them:
Financial planning is an important part of any business's success. When you're creating or updating your plan, don't forget that strategic advice can make all the difference in achieving goals! Whether it be funds management and financing options for investors with high expectations about growth potential - immunity from risky decisions-or protecting against downside risk by having a detailed outlook on cash flow scenarios; we have professionals who will help put together solutions tailored just right around what YOU need them to do best.
Fractional CFOs help you measure what matters - When it comes to measuring success in your business, there's a lot of different factors to take into account. How many sales did you make this month? Are your profits up or down from last year? How does your company compare to others in your industry? While all of these are important measures, they don't tell the whole story. In order to really know if your business is thriving, you need to look at its financial health holistically.
In business, you are only as good as the people around you. You'll find that we have a number of different experts on our team for each position which allows us to be versatile and fill any gaps in knowledge or experience necessary when running your small company effectively from start-up through growth stages!
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You might have heard these grim statistics before: more than 80% of all small businesses fail within 10 years, and more than 80% of those businesses fail due to cash flow issues. While some dispute the exact numbers, the underlying issue can't be. Cash flow is important. Period.
One would think that one of the most important business areas would be well understood. That isn't the case though. Cash flow is still one of the most ill-understood topics within the small business community. And forecasting cash flow? Even though it is just as important, it is even more misunderstood.
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In this post we will shine light on these misunderstandings, talking about what cash flow is, what cash flow forecasting is, the different types of cash flow forecasting there are, and how forecasting your cash flow can greatly benefit your small business whether you're a founder of a startup or a web3 company, or a professional that has ventured out on their own (say a veterinarian, dentist, chiropractor, optometrist or lawyer).
So, let's start with the basics: what is cash flow?
Cash flow is simply the movement of money in and out of your business. Money coming in is called inflow, while money going out is called outflow. Your business' cash flows can be positive (more cash inflows than outflows), negative (more cash outflows than inflows), or neutral (equal cash inflows and cash outflows).
The movement of money within, and through, any business is extremely important. At a basic level, every entrepreneur sets out to make money. So stripping everything down, each business' ability to generate positive cash flow, consistently over time, determines just how good that business is performing.
The more cash flow a business can make, the better it is doing.
Now, the above discussion on the importance of cash flow might seem overly simplified, and it is, but most small business owners don't have a great handle on this basic construct.
And there are two reasons for this:
Double entry accounting underpins all accounting as we know it. It requires that every financial transaction to be recorded in at least two different accounts. For example, when you make a sale, you would record this transaction both in your sales account on your income statement and your cash account on your balance sheet.
While this system provides greater accuracy and transparency around business finances, it also makes measuring cash flow more difficult. And that's because changes in cash can occur in two places: your income statement or your balance sheet.
There are two basic methods of accounting: cash accounting and accrual accounting.
Cash accounting only records transactions when the actual cash changes hands. So if you make a sale and the customer pays later, you wouldn't record that transaction until you collect payment from the customer.
Accrual accounting records income and expenses as they are earned or incurred, regardless of when any actual cash is received or paid out. Using our same example, if you make a sale and the customer pays later, accrual accounting would record the sale right away and create an accounts receivable. It would then eliminate that receivable and increase your cash balance when you collected payment.
Accrual accounting is a double edged sword. It creates financial statements that are more accurate and reliable for various users, but also creates timing differences, estimates and other complexities that aren't necessarily well understood by business owners.
The cash flow statement is the report that helps overcome the shortcomings that accrual accounting and double entry accounting processes make. This report ties the balance sheet and income statement together within your typical financial reporting. It measures all cash inflows, all cash outflows and eliminates any non-cash estimates that are also contained within your financials. And ultimately it reconciles all of this information to the cash balance contained within all of your bank accounts.
You can see two different forms of cash flow statements: those using the direct method and those using the indirect method.
Cash flow statements using the direct method are considered by some to be more accurate. This method reports all cash inflows and cash outflows from your business operations separately from any other inflows or outflows. This could include things like customer payments, vendor payments, interest income, dividends and other operational items.
The indirect method is a bit more simplified. It adjusts your net income for any timing differences between when you record accrual based items and when the actual cash is paid or received. This reconciles your net income to your actual cash. While this method isn't as detailed as the direct method, it's also not as susceptible to error.
Regardless of the method used, cash flow statements are a very important piece of your financial picture. As mentioned previously, they show how cash moves through your business. That said, cash flow statements are historical in nature. They show you what your business did, but not where your business is going. To see that kind of information, you will want to use a cash flow forecast.
A cash flow forecast is a projection of all of your future cash flows. It is a best guess, based on all available information, of what you expect to happen in the future. This includes things like expected:
A good cash flow forecast will show you:
This will give you a clear picture of where your business is heading, and how much cash you will have on hand at any point in time.
We touched on some of the high level benefits of cash flow forecasting in our Definitive Guide To Managerial Accounting For Small Businesses. Simply put, knowing the future net cash flow of your business, and your estimated cash balance at any point in time gives you a lot of power as a business owner. You will be able to:
By forecasting cash flow, you can see when your business might have a shortfall of cash. This allows you to take steps to avoid or mitigate the effects of a cash shortage, such as delaying expenditures, extending payments on accounts payable or shoring up working capital with short term debt.
Cash flow forecasting will give you a better understanding of how money moves within your business allowing you to more effectively manage your activities with operating cash. This can be particularly helpful if your business:
Knowing when and how you will get paid, and how and when you will make payments will make you a lot less reliant on debt and lines of credit.
A cash flow forecast will give you a better understanding of your business's financial health. This information can then be used to make better informed decisions about how to best use your resources.
Do you have enough cash to buy the equipment you need to grow and hit your sales targets? Can you afford to hire that stellar employee you interviewed? If you open a new location how will that impact your bank account in the short and long term?
Whether you have negative cash flow or a host of cash surpluses, thinking through exactly how you will progress your business, and knowing the effects of these decisions is an extremely helpful exercise. It will surely boost your confidence.
A cash flow forecast will help you track your progress towards your strategic business and financial goals. The information gleaned from the cash flow forecasting process itself can be used to adjust your budgets and your business plans, making these documents dynamic and more relevant as your operations change.
There are a number of different types of cash flow forecasts. Just like cash flow statements there are different methods you can use to create a cash flow forecast. And depending on your goals, the time frame you use in your cash flow projection should change.
Similar to its cash flow statement counterpart, a direct forecasting shows the exact cash inflows and outflows that result from your business' operations. This is the more straightforward approach to cash flow forecasting as it directly ties to all incoming cash receipts and outgoing cash payments.
Indirect forecasting does not start with your business' operational cash inflow and cash outflows. Rather, it begins with your company's net income figure. From there, non-cash items and changes in working capital are added back into or deducted from the bottom line to get to a net cash flow figure.
Indirect cash flow forecasting is more common associated with three way cash flow forecasting. This cash flow projection method forecasts your income statement, balance sheet and cash flow statement and ties them altogether. Hence the term three way forecasting.
Three way cash flow forecasting is sometimes viewed as the most robust way to cash flow forecast. It eliminates a lot of possibility for errors, especially when using a spreadsheet, and also presents bank ready financial statement projections that can be used for lending purposes. This method is typically a lot more customized however, can take a lot more time to create and maintain, and sometimes isn't as easily understood by entrepreneurs.
Long term cash flow projections are typically forecast from one year to five years out, with most going to three years in range. This type of cash flow forecast is most often associated with strategic planning and indirect/three way cash flow forecasts. These types of estimates are often used to:
A short term cash flow forecast is much more operational in nature. It can range from days to months in terms of time frame, and often does not go beyond a year. This type of forecast is much more granular in nature, and has much more accurate information in terms of timing. It is often updated quite frequently, as regular as weekly forecasts or daily, and is ultimately used to answer the question "do I have enough cash to do X?" in the near term.
The biggest difference between a short term and long term cash flow forecast is its use. Long term forecasts are more strategic, while short term forecasts are more operational.
The best analogy is a road trip using a map. A long term cash flow forecast determines exactly where you are going and loosely determines how you will get there. A short term cash flow forecast is used while you are driving to that destination, constantly shifting due to traffic, construction and road closures.
It is often a best practice to use both a long term strategic and a short term operational cash flow forecast.
An accurate cash flow forecast can be a game changer. Whether you're a professional, such as a veterinarian, dentist, chiropractor, optometrist or lawyer, or a founder of a startup or a web3 company, you will experience cash flow issues. Studies show that the vast majority of business owners have at least once in their lives.
Knowing exactly when that cash flow issue will come, and what you are able to do to mitigate the problem is a definite advantage. One that will let you sleep a whole lot better at night. And that's exactly why cash flow forecasting is a must-have tool.
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Knowing exactly where your business cash flow is headed will let you sleep a whole lot better at night. And that's exactly why cash flow forecasts are a must have tool for every small business.
As a business owner you are busy. This definitive guide will show how managerial accounting will get you back to your entrepreneurial dream: creating something you love, helping people in the process, and earning money and free time while doing so.