Whether you are experiencing an uncertain business environment, or you are enjoying a time of strong business confidence, you should still plan your cash flow. One method of planning your cash flow is using scenario planning. Scenario planning offers you the opportunity to see how your business would react in different scenarios. You can create as many scenarios as you see fit, but just ensure they are realistic.
Below is a scenario that outlines two projects, and what they are worth to the business. They look similar in value, but if you look at the graph at the bottom it will highlight how your cashflow is affected by which project you choose to undertake.
You’ve won a $1m contract commencing next month. It’s your dream project and opens the door for more. It will take 6 months to complete. You get paid a $100,000 deposit, and the rest on completion of the project. You’re going to make $500,000 out of the project.
You have a series of smaller contracts that will make you $400,000 over the same time period (6 months). You get paid upfront every 2 months in equal increments.
Which of these is the better option? A lot of people would go Scenario A – it’s worth $500,000 vs $400,000 for Scenario B. But let’s break it down further to understand how each project will affect your cashflow over the same amount of time.
Project A is going to earn you $500,000 at the end of 6 months. The deposit covers the initial materials purchased. You have to fund the remaining materials, labour and other costs. So, for 5 months, you’re in the red.
Project B doesn’t give you the same thrill, however it does give you a consist payment during the time period, which means you will not have to pay interest on borrowings or accounts as you are able to keep up with consist repayments. The payment at the start of month 1 covers 100% of your expenses, and for the alternate month you have to fund the materials, labour and other costs.
You need to be prepared for these types of scenarios to take place in your business and understand the long-term effects of choosing the right payment options for your business. Understanding how to make your cash flow robust so your business can be future-proofed is the central concept when planning your cash flow scenarios.
If you need a further explanation on how to use scenarios to project and plan your cash flow to future proof your business- we would be happy to help.