How to plan cash flow three weeks ahead in an SME
Many SME owners check their bank balance every day and judge their company’s financial situation on that basis. But that is not enough. The bank balance shows the past and the present; it does not answer the most important question: in two or three weeks’ time, will I still have the money to pay what I owe on time?
My consulting experience shows that liquidity problems rarely appear suddenly. Most often they are the result of a lack of systematic cash flow planning. That is why one of the simplest and, at the same time, most effective tools of financial management is a three-week cash flow forecast, updated every week.
Liquidity management, responsibility for cash flow, working capital and the answer to the question of why a profitable company can fail are discussed in detail in my book Finanse dla niefinansistów w praktyce (Finance for Non-Financial Managers in Practice).
Why three weeks?
In large corporations, forecasts tend to cover 13 weeks, that is, a whole quarter. For most Polish SMEs, however, what matters most is the outlook for the next couple of weeks or so, because their sales tend to be less stable – and payments certainly are, coming from customers who routinely take advantage of trade credit.
Within three weeks, the following usually fall due or come in:
salary payments,
payments to suppliers,
lease and loan instalments,
taxes and social security contributions (ZUS),
expected receipts from customers.
It is over this short stretch of time that the future is easiest to predict with reasonable accuracy. At the same time, it is long enough to spot a problem coming and react in time. This is borne out by the practices used in modern liquidity management, where regular forecasting of cash inflows and outflows in short cycles is key.
How do you create a three-week cash flow forecast?
You do not need to invest in advanced financial systems straight away. A simple Excel spreadsheet is enough to start with.
In the first column we enter the current cash balance.
Then we create three further columns:
Week 1
Week 2
Week 3
For each week we plan:
Inflows
payments from customers for invoices issued,
advance payments from new customers,
tax refunds,
other expected inflows, such as capital injections from the shareholders or loan tranches paid out by banks.
Outflows
salaries,
social security contributions (ZUS) and taxes,
purchases of materials and goods,
lease payments,
loan repayments,
rent,
marketing,
other operating costs.
All amounts are gross, including VAT. Only then do we estimate whether, in a given week (for example, the last week of the month), VAT has to be paid or is due to be refunded. In the latter case, bear in mind that the refund is not immediate, so the amount to enter is 0.
Then we calculate:
Opening balance + inflows − outflows = closing balance
The closing balance of one week becomes the opening balance of the next.
This very simple exercise gives a business owner far more control than analysing a historical profit and loss account or the bank balance alone. Forecasting should be based on specific payment dates, not solely on sales or cost figures.
Estimating the VAT payable is one of the most common problems. Cash flow is planned in gross amounts, because those are the amounts that actually flow into and out of the account. The VAT payable, however, depends on when the tax liability arises and on when the right to deduct arises, so it does not follow automatically from the cash flows.
The rule is simple and concerns calculating the VAT for the previous month, which is due for payment on the 25th of the current month.
VAT payable = output VAT on sales − deductible input VAT on purchases.
How do you estimate the VAT for the previous month without an accountant’s help?
Export all the sales invoices for the previous month.
Add up the VAT on those invoices.
Export all the purchase invoices.
Add up the deductible VAT.
Add any corrections (if there were any).
Subtract the purchase VAT from the sales VAT.
Corporate income tax (CIT) has to be handled in a similar way, but looking at the previous month’s result net, without VAT.
Estimated CIT for the month = estimated taxable income for the month × the CIT rate (for example 19% or 9%)
Owners often make the mistake of calculating:
EBIT × 19%
The correct calculation is:
taxable income × 19%
This is because the taxable result may differ from the accounting result owing to:
tax depreciation,
leases,
costs that are not tax-deductible,
exchange rate differences,
interest,
tax reliefs.
In a cash flow model for the owner, it is worth showing three items separately:
VAT payable
CIT payable
The owners’ social security contributions (ZUS) and personal income tax (PIT)
The biggest barriers to cash flow planning
Knowledge alone is not enough. In my book I stress repeatedly that between understanding and implementation there are “points of resistance” that block real action. The same is true of managing cash flows.
1. The owner is too optimistic
Entrepreneurs are optimists by nature. They assume that the customer will pay on time, sales will grow and the problem will solve itself. Reality often looks different.
If your customers regularly pay after 45 days, do not enter payment after 30 days in the forecast. The forecast must be based on how customers actually behave, not on wishful thinking.
2. Confusing sales with cash
This is one of the most common mistakes. A company can have a full order book and, at the same time, be short of money. Sales increase revenue, but they do not always mean cash coming in straight away. That is exactly why profitable companies sometimes go bankrupt. This subject is one of the key elements of what the book has to say about cash flow.
3. No discipline in updating
Creating a forecast once achieves little. Cash flow is like a car’s sat nav: the route has to be updated continuously. That is why the best practice is to review the forecast every week and move the horizon forward by another week. Experts in liquidity management call this approach a rolling forecast.
4. Nobody is responsible for cash
In many companies the owner thinks that the accounts department is responsible for the money. That is a misunderstanding. The accounts department accounts for the past. The board and the managers are responsible for the future. In the book I draw attention to the question: “Who is responsible for cash flow?” The answer is: every manager whose decisions affect sales, purchasing, stock and payment terms. Every manager must be held to account for their part of the cash flow.
How do you overcome these barriers?
Introduce a regular financial rhythm
Once a week, spend 30 minutes updating the forecast – ideally on the same day and at the same time.
Measure receivables
Keep track of:
the value of overdue receivables,
your largest debtors,
the forecast dates of receipts.
If a customer has not paid on time for a year, do not assume they will suddenly start.
Create scenarios
For every forecast it is worth preparing three versions:
optimistic,
realistic,
pessimistic – perhaps the one to start with.
This approach lets you react to risks more quickly.
Build a cash buffer
In an ideal world, a company has a financial reserve that covers at least a few weeks of fixed costs. Then a single late payment does not cause an immediate crisis.
Link sales to finance
Salespeople should be held to account not only for the value of their sales but also for whether their customers pay on time. Sales and cash flow cannot exist in two different worlds.
Summary
For most Polish SMEs, the greatest threat is not a lack of customers, the competition or even falling profitability. The greatest threat is the loss of liquidity.
Want to find out more?
If you are interested in a practical approach to financial management, cash flow, profitability, budgeting and business decision-making, you will find more in my book Finanse dla niefinansistów w praktyce (Finance for Non-Financial Managers in Practice) and in the course Kowale Biznesu Tłumaczą Finanse (“The Business Smiths Explain Finance”), created for business owners and managers who want to make better business decisions and develop their organisations more effectively. Cash flow, responsibility for cash flows, budget planning and improving liquidity form an important part of both the book and the course.