How cash flow modelling can proactively assess your business in uncertain times

15 May 2020

Gracia Kabongo, Manager, Corporate Finance |
David McCourt, Partner, Corporate Finance |
Andrew McFarlane, Partner, Advisory, Corporate Finance, Mergers and Acquisitions |

With COVID-19 significantly affecting the current economic climate, business owners are asking, how do we forecast our cash flows over the coming months given the level of uncertainty? And, if we need to fund ourselves through this period - how much do we really need to raise to provide sufficient headroom?

The key in answering these questions is to be proactive.

Businesses need to be making informed and timely decisions. These decisions will be critical in ensuring their business remains solvent during these times, but will also allow them to plan more effectively and drive strategies that will see them come out of this crisis stronger.

There’s no doubt, that business owners will be assessing their cash flows as a first step, to see where they can free-up and maximise cash flow. In normal circumstances, cash flow issues are the most cited reason for business failure. When this is compounded by the implications of the COVID-19 virus impacting workforce planning, customers and suppliers, for at least the next six months, it further heightens risk.

With this in mind, your company will need to take practical measures to set itself up for the bridge period and create a springboard for when it comes out on the other side. It is important not only to keep the near term cash requirements in mind but be able to prepare to jump-start your business and assess how much cash would be required to do so. In these complex times, businesses must look at various assumptions to see what the outcomes will be.

The cash flow model

This is where cash flow modelling can be used as a proactive business approach when assessing current and future cash flow requirements under various scenarios. This detailed modelling is not only a tool to assess current needs, but also drive future growth, add predictability to your decisions, and give more confidence to your equity partners.

Cash flow modelling works two-fold:

  • It is fundamental to ensuring you can pre-emptively manage your short-term cash requirements and forecast future cash flows as flexibly as possible given the tumultuous times and uncharted waters we’re yet to navigate over the coming months.
  • Cash flow forecasting is equally important when approaching external parties for your funding requirements. You will be able to identify how much funding is required under different scenarios – and consider your various funding options, and available sources of funding.

Creating the model

So how do you commence the modelling and forecast process?   To get started, you will need to ask a few questions to ensure you are on the right track.

Firstly, what is the purpose of your modelling?

A model is only as good as its construction and cannot be built in isolation. When preparing your model its purpose must be defined, once you have defined its purpose you can understand the types of information you need to feed into it.  For example:

  • Are you performing a break-even analysis?
  • Are you assessing your short-term cash requirements?
  • Do you require funding or assessing your business for valuation purposes?
  • Are you assessing the impact of future growth prospects?

By accurately communicating its purpose, it can help drive your business forward, because it helps drive action to the desired outcome, acting as a blueprint to get you there.

Secondly, what does a robust model look like?

There are four key indicators of a robust model, including:

  1. It clearly articulates the key drivers of your business. That is, it shows the specific levers of where the business derives value.
  2. The key inputs and assumptions made (based on business drivers) are kept separate. This allows you to make changes to these inputs in these uncertain times, allowing the model to be flexible.
  3. A robust model is integrated. The income statement, cash flow statement and balance sheet are built in a way that they feed into each other (a three-way model). A three-way forecast provides more integrity and is looked upon more favourably when accessing funding.
  4. A robust model allows for scenario analysis and the ability to assess what impact different scenarios will have on your business.

To ensure your modelling remains valuable, it’s important to continually reassess it. It’s important to get the finer details right, so that it can be as accurate as possible. Where assumptions are volatile, it is important to understand the risk by running a range of scenarios. While this can take time, in the long-run it will be advantageous in supporting your business and business plans.

Overall, modelling can assist in navigating through these times. BDO are available to advise and assist you in determine how best to forecast cash flows in the foreseeable future and provide key insight to achieve your desired goal.

At BDO, we have a team that can assist in building a customised financial model that meets your business requirements. Contact a local partner today.