The Importance of Cash Flow Forecasting for Startups
Accountants for Entrepreneurs and Tech Startups
For many startup founders, one of the chief causes for concern is availability of cash – often referred to as runway. We’ve all heard a variation of the phrase, cash is king, and cash often forms the stepping stones between funding rounds for startups on which their business moves forward. Without which they would quickly sink.
It’s for this reason that regular, accurate cashflow forecasting is essential – which is why our accountants for entrepreneurs in London have taken a detailed look at in this week’s newsletter.
Cash Based Accounting Versus Cashflow Forecasting
According to Chartered accountants in the UK Cashflow forecasting shouldn’t be confused with cash-based accounting – a process which recognises revenues and expenses at the time cash is received or paid. Founders might think that by noting down incoming revenue and comparing it with known expenses, they are coming up with an accurate picture of the business’s financial health. However, this approach doesn’t consider more complex accounting treatments such as cash in advance and the accrual of tax liabilities or bad debt provisions. All of which can cause unwelcome surprises for startups.
Instead, startups should utilise accrual-based accounting methods, which recognizes income at the time revenue is earned and records expenses when liabilities are incurred regardless of when cash is received or paid. This should be reflected in regularly updated profit and loss accounts, balance sheets and cashflow forecasts so founders can make informed decisions based on the financial health of the business now and in the future.
Cashflow Forecasting as a Business Strategy
According to accounting companies in London forecasting and budgeting are about much more than crunching numbers. They should be prepared in line with the long-term aspirations of founders, providing critical commentary for the growth trajectory of the business and revisited and adjusted regularly.
The budget informs everything from marketing spend and new client acquisition to increasing headcount, purchasing software, or incentivising key employees. It’s for these reasons that cashflow forecasting should sit at the heart of any business plan or growth strategy as per best accountants in London. The fundamental question therefore is do startups create an accurate forecast that balances ambition with pragmatism?
Ensuring Accuracy
Initially, relevant historical data is the best starting point, combined with a sensible approach to adjusting as circumstances change.
However, circumstances change so quickly for startups as they scale that the usefulness of historical data might be limited. Expenditure can be so variable from one period to the next depending on what is happening in the business it can make accurate reporting based solely on historical data difficult. Plus, if you’ve only been operational for six months, you won’t have much data to draw on in the first place.
Don’t let that stop you as even the best forecasts will never be 100% accurate and no stakeholder, be they investor, shareholder, or employee, should expect them to be. What they will expect is you to have sensible, defensible answers as to why your budget and forecast are what they are.
Historical data doesn’t just have to pertain to your own business. It can also come from the wider market and especially competitors. Augment what data you do have for your business with secondary research. Start by defining your addressable market in terms of products, demographics, region, prices, distribution, and growth. This will provide you with those sensible, defensible justifications we just mentioned.
Variance Analysis
Since no forecast is ever going to be 100% accurate, regardless of how good the data you input is initially, a critical aspect of continuing to make informed decision relies on adjusting. Founders should regularly make time to compare your actual performance to your forecasted performance and undertake variance analysis.
Variance analysis is important because it allows you to adjust your forecast and provides a structured opportunity to analyse performance. It will highlight problems in product development, marketing, sales, recruitment, and the general understanding of your market. Identifying these problems early gives your business the best chance to make iterations and to improve performance.
It’s important to address the variance and why it’s arising. If you can control it, you can make changes. If you can’t, amend your forecast to take the variance into account.
Technology
Like many aspects of running a business, technology can make forecasting much simpler. Dragon Argent recommend Xero to clients, and in this context, it has a variance analysis tool that can be used to help with financial reporting.
Software can automate many of the nuances of forecasting and help you identify trends as you grow and progress. The aim, as already stated is not perfection, but careful control of the assumptions around growth.
We are one of the best Xero Accountants in London supporting 90% of our clients who are using Xero accounting software. We also provide support for the client who uses QuickBooks.
The Art of the Future
Ultimately, forecasting is how as a founder you understand how much cash you need in the future to meet your liabilities and perhaps more importantly, when. This is not only important for day-to-day decisioning making on expenditure, but also in the context of startups, for investors.
Not only will they expect the leadership team to have a strong grasp of likely financial performance, more fundamentally, they will want to know when they can expect a return on their investment!
Dragon Argent accountancy services in London specialises in working with startups and SMEs to provide them with accurate and regular financial reports. This is so, so important for businesses that are operating on a tight budget with volatile cashflow. If you would like an exploratory discussion to understand how our accountancy team might be able to improve your decision making, please get in touch.
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