At the end of the first week, before you have sent out your first invoice you need $25K to cover your payroll costs and to make things worse by the end of the second week you need a total of $50K and you have yet to collect any money from your customers.
In this case, if you had created a monthly cash flow forecast to determine your cash requirements and funded your organization accordingly you would be out of business five days after you acquired it. In other words, in this specific case a monthly cash flow forecast would have been absolutely useless and a weekly cash flow forecast or budget is what should have been created.
You should also take a few other items into consideration when determining the interval for your cash flow forecast. A lot of expenses are not based on time intervals but on calendar dates. For instance you will not pay the rent or mortgage or vehicle lease payments every four weeks, you will pay them on a specific date, usually the first of each month. If you have a weekly payroll you will have four of the twelve months in the year with five payroll periods. A standard monthly cash flow forecast usually assumes that you pay all your bills at the end of the month and that all months are the same duration.
If after reviewing the company that you are considering acquiring and you still cannot determine a cash flow period or interval, use one day and run it out for at least three months if not six. Use actual dates and the names of the days so that you will see the effects that the first of the month has, the effect a Friday may have, as well as the different quantities of days within any specific month. It is always safer to use shorter periods of time then longer periods of time when creating your cash flow forecast. Use a standard computer spreadsheet program and it will make creating your cash flow forecast a breeze.
It is relatively easy to forecast and then chart the cash that is leaving the company. It is much more difficult to forecast and hence chart the arrival of cash into the company. Do not forget to allow for the time it takes for checks and credit card deposits to actually be available in your account. Local checks may be held for two business days, in state checks may be held for five business days and out of state checks may be held for as long as seven business days, checks from foreign countries may be held for as long as 30 days whereas credit card deposits are generally two business (banking) days.
We have created a cash flow calculator that you can download for free. (MS Excel required)
Cash Flow is determined by subtracting the Total Cash Expenses from the Total Cash Receipts. If the Cash Flow number is positive at this point your business is in very good financial shape.
A negative number in the Cash Flow box does not mean that the business is on the verge of collapse providing you have a larger number in the Available Bank Line of Credit box directly below.
Solvency is determined by adding the Available Bank Line of Credit number to the Cash Flow number. As long as the number in the Solvency column is positive your business will survive. The closer the Solvency number is to zero the worse your overall ability is to meet your expenses and pay your bills when they are due.
If you are truly going to benefit from creating the cash flow spreadsheet you have to be honest with yourself especially in the area of when cash receipts are expected to arrive in your bank account. Most people underestimate or are overly optimistic when it comes to the average collection period for receivables. I suggest that when performing due diligence that you take a group of invoices at random and then see how long it was before the money was received. This will give you the best indication of the length of time that it takes for receivables to be collected. Do not think that because you are operating a cash business such as a retail store that you will always be cash flow positive. You will most likely have to pay for your inventory, rent and many other expenses in advance.