Cashflow forecasting #2 - When will I get paid?

Introduction

If you’ve read the Manifesto for Business Improvement on this blog you’ll quickly notice that 3 of the 6 “Rules” are related to cashflow.

In part 1 of this series on cash flow forecasting I outlined how to get a handle on what your cash position is now.

This second post explains why knowing who owes you what, and when they will pay, is the next component required to being able to produce a reliable rolling cash forecast.

Debtors are assets, which is good, right?

Yes they are…. and no it isn’t!

It is more useful to think of debtors as a deferred receipt of cash for goods and services already supplied by your business…. if there is a balance sitting on your Sales Ledger as a debtor, the money remains in your customer’s account and not in yours. This means that you may have to borrow money to pay for more stock, wages, rent or some other business cost. To that extent, you are helping to fund your customer’s business through your borrowing.

So, even though they are seen as an asset, debtors are bad, if unavoidable, and we should seek to minimise them by getting the cash in as early as possible.

Tidy your Sales Ledger

Knowing who owes you money, and when it will be paid, will help to keep debtors under control and allow you to forecast your cash needs accurately helping to improve collections.

The biggest impediment to both forecasting receipts, and actually getting the cash in, is an untidy Sales Ledger.

Strategies for tidying and improving collection

Below are five steps to take that will improve the state of the Sales Ledger….

1. Agree payment terms up front - making a sale without agreeing when it should be paid for should never happen… but you’d be surprised how often it does. Most customers have standard purchase terms, and these may specify when an invoice will be paid. Make sure that you agree in writing what the payment terms actually are and get them signed off by the customer - otherwise you risk falling back on their terms, which could be very onerous.

2. Invoice every day - This may seem obvious to many, but it is very important to make sure that all goods and services you provide to customers are invoiced correctly and posted to the ledger on a daily basis. Many companies don’t do this, risking omissions and errors and allowing customers to delay payment. Additionally, if your invoicing is days or weeks behind, you can’t accurately forecast your potential receipts.

3. Tag invoices with the due date - based on the terms agreed in step #1 each invoice should be tagged with a receipt date. Ideally your accounting system should do this automatically which will allow you to easily generate a forward forecast.

4. Deal with customer complaints/queries promptly and issue credit notes that are due in a timely manner - The biggest source of delayed payment is from customers using errors as an excuse not to pay - these might be in delivery, pricing, a quality or spec issue…. or the old “we never received that invoice” trick. So deal with these immediately, and don’t let errors become a source of friction in the receipt cycle.

5. Post cash received every day - and allocate against outstanding invoices. This way only the invoices actually owed will show up on the ledger and your forecast will be accurate. If there are allocation queries deal with these by clarifying with the customer, if possible, which invoices are being paid.

A note on contras/back charges

Many clients will ‘contra’ or ‘back charge’ for services that they provide. Examples are:

• marketing/promotions/over-riders
• damage allowances
• warehousing

These need to be agreed up front and, where valid, posted to the Sales Ledger as soon as they are known, otherwise there is a risk that potential cash receipts will be overstated.

Receipts forecast

Sales already delivered

Now you’ve sorted your Sales Ledger into a nice and tidy state you should be able to pull a forecast together of when you are likely to be paid for work already completed and invoiced. Ideally this should come directly from the accounting system, and be based on the agreed due date for each invoice - usually there will be a report available to do this or one can be written.

Alternatively this post shows how to create a weekly receipts forecast by customer in LibreOffice from a csv file directly exported from the uzERP Sales Ledger system. You could do the same using the output from your accounting system, by using LibreOffice or Excel if that is the spreadsheet you use.

In part 1 I stressed that any cash forecast needs to go out 13 weeks to be useful. Clearly, unless you allow very long payment terms (greater than 90 days from delivery) the receipts forecast from the sales ledger will only take you so far.

Forward order book

To get to the next level you should therefore be looking at your forward order book and forecasting….

1. when will these orders be delivered
2. based on agreed payment terms, when would the payment be made assuming the delivery date in #1 is achieved

The uzERP system allows this information to be pulled together quite easily, based on orders in the system (which have a due delivery date) combined with the customers’ payment terms from the ledger.

Sales forecast

If you have a sales forecast that goes beyond current orders (maybe you work on short lead times and have a small confirmed order book) then you will need to make estimates of the orders and work out when they might be paid. Obviously there will be a certain amount of guesswork, so where might this information come from….

1. forward contracts where there is repeatability and regular deliveries, but where the firm orders don’t arrive until a few days before shipment. In this situation there is a ‘beat’ so the cash forecast can be estimated based on best information from the sales force.
2. quotations already made - if you do quotes for new business these could be quantified, as per the order book above.

Putting it together

Pulling the three strands together gives a forecast cash receipt date for potential future deliveries combined with the forecast receipts from sales already made giving a better forward view.

Obviously, because the order book/forecast sales have not yet taken place the forward forecast is less accurate, especially if due delivery dates are not met, but it does give a powerful insight into what receipts look like over a longer time window on a rolling basis.

Summary

Forecasting when you will be paid is a key component in making sure your business is adequately funded. Getting your procedures right will give you a tidy Sales Ledger leading to a more accurate forecast and, crucially, allowing improvement in collection activity to get receipts in on-time and in-full.

Adding in an estimate based on order book and sales forecast gives a longer term view and will allow a 13 week rolling receipts estimate to be put together which can be plugged into the overall cashflow model.

And finally…. if you want to know more about how we can help you improve your business through better systems and improved information then do please get in touch via the Contacts Page.