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Business man holding board on the background, Cash flow (basketman23/Getty Images/iStockphoto)
Business man holding board on the background, Cash flow (basketman23/Getty Images/iStockphoto)

How to develop and manage a cash flow model in five simple steps Add to ...

Having a fiscal year end that’s the same as the calendar year may drive your accountant nuts, but the year end is a time for planning and goal setting for the new year. But even though you set your revenue targets and budget for investments, there is an overwhelming anxiety every January related to the fact that no matter how much planning you do, you can’t predict the future -- and things can change for the worse when you least expect it.

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For me, that anxiety stems back to the dot-com crash in 2001. At the time, we had just developed a growth plan to invest in doubling the size of Delvinia and we were looking to hire a number of staff. We assumed the momentum we had experienced throughout the previous year was the beginning a growth period that had no end in sight. Boy, were we wrong.

The dot-com crash created so much fear in the marketplace. Our clients were struggling to justify their investment in digital and many decided to postpone their digital activities until the dust settled.

Our optimism was replaced by uncertainty and we were faced with some agonizing business decisions, decisions that could potentially devastate our dreams and all that we had invested in the business just a few years prior.

It was the first time I saw our cash flow running out. We were deep into our line of credit. I knew our receivables wouldn’t carry us for long and we would have to lay people off. Paying severance to the staff would deplete our cash flow quickly, but keeping them around would only delay the inevitable.

Following a turbulent summer, our bank put us into special loans in September. Yes, that September; a month that will remain infamous for generations to come.

The events of September 11 only caused more anxiety in the marketplace and we had exceeded our margin coverage for our line of credit. The bank was understandably concerned about whether we would be able to carry the debt.

This was my first experience with special loans. At the time I believed if a company was placed into special loans, it was because the bank had written it off and was trying to see how much money it could collect before shutting it down.

Well, I realized that this wasn’t the case: The bank did not shut us down. In fact, it stood by our side. Once we worked with our accounting firm to develop a cash flow model that the bank was comfortable with, they allowed us to pay down our loans while still running our company.

This was a defining moment for me. Although it was a major crisis in my business life, that year was when I really learned the importance of developing a cash flow model.

After a year of demonstrating our ability to manage cash, we were taken out of special loans and our regular banking relationship was restored. We had survived the most devastating correction in the technology world to date and the first major cash flow crisis since I had launched the business.

I had déjà vu when the global subprime mortgage crisis hit in May 2008. We had just come off our best year to date and our cash flow and retained earnings were strong. When the subprime bubble burst, our cash flow model helped us manage through the next five years of economic uncertainty.

Looking back, I realize that my previous experience helped me to remain calm and focused throughout this period.

So, how do you develop and manage a cash flow model? Here are five guidelines to follow:

1. Speak to your accountant. They are experts at developing cash flow models and since they also understand how banks think, they can help you develop a model that will ensure you are on top of your banking relationship. Even if you have to pay them to help you, it’s well worth the investment. If you don’t have an accountant, or are looking for one, asking about their ability to build a cash flow model for you is a great discussion to begin with.

2. Don’t rely on anyone else to manage your cash flow. If you don’t understand it yourself, you won’t be able to trust the forecast of your cash flow into the future. Nothing is worse than making business decisions based on a model that doesn’t accurately portray your financial situation.

3. Make sure your cash flow replicates the way you run your business. Whether that’s with payroll, multiple business units, lines of credit or any other aspect of your business – your cash flow should be a snapshot of how you think about running your financial affairs.

4. Align your model with your available credit limits. The most important part of a cash flow model is to forecast your cash flow relative to your line of credit limit and the margin coverage of your accounts receivables. (Most banks require that your line of credit should never exceed 75 per cent of your accounts receivables.)

5. Remember that a cash flow model is a living document. Update your model every year to ensure it remains relevant. You never know when your economic conditions can change. If your model is continually maintained, it will give you peace of mind about the financial state of your business in the near future.

Understanding the importance of managing cash flow is one element of what I call my five Ps of success: patience, people, perseverance, perspective and passion. Managing cash flow is part of perseverance. While all five Ps have been necessary for me, perseverance is essential for any entrepreneur.

You can never allow yourself to be defeated and the only way you ever truly fail is when you give up. At times I have been called a bull in a china shop, but my perseverance has allowed me to forge ahead and come out stronger. And managing cash flow helps me to manage the anxiety that comes with setbacks and financial uncertainty.

Remember, you’re running a business and success is measured by its ability to manage cash flow and be profitable. There will always be ups and downs, but if you can understand your cash flow today and tomorrow, you will be able to manage any situation that threatens your cash flow and perhaps even your banking relationship. In the end, cash flow is king.

Adam Froman is the CEO of Delvinia, a Toronto-based digital strategy firm he founded in 1998. As an entrepreneur, Adam has dedicated himself and his company to helping clients respond to the opportunities and challenges that digital technologies bring to customer relationships. His first book, Delve In, Dig Deep: An Entrepreneurial Journey, is available in eBook stores now.

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