Sales Forecasts vs Cash Flow Forecasts

There’s an old saying:

Sales is Vanity. Profit is Opinion. Cash is Fact.

That description of sales is probably a bit harsh as every business does have to have make sales. No sales means no profit and definitely no cash.

To paraphrase George Orwell in Animal Farm: “Not all sales are created equal”. Chasing sales at the expense of margins isn’t a sustainable strategy. But even sales that provide healthy profit margins must be turned into cash at some stage, preferably sooner rather than later. If you don’t, you haven’t made a sale and potentially cost yourself a lot of money if you cannot recover the associated cost of goods or services.

When doing cash flow forecasts, you need to make a critical assessment of how long it will take you to collect the money from the forecast sales, as well as other potential risks that could affect the collectability. Sound cash flow management requires good understanding of your sales to cash conversion cycle.

Key Factors That Affect Sales to Cash Conversion Cycle

1. Credit Terms & Bad Debts

Some of the issues you need to take into account when doing your cash flow forecasts include:

• What credit terms do you offer your customers?
• What is the history of your debtor collections? Take a look at the profile of your aged debtors listing. Your terms may be 30 days. But the reality may be that say, no one pays you within the stated terms, 75% of your debtors only pay around 45 days, 20% around 60 days and the balance going out past 90 days.
• Could you tighten up your debt collections to shorten the lag between making the sale and collecting the cash? Remember, the squeaky wheel is the one that gets oiled. You don’t want to be an accidental financier of your customers.
• What’s the bad debt history for your business? These are sales that will never turn into cash. And the cash collections in your cash flow forecasts will need to allow for this.
  If you find that you have persistent bad debts eg around 5% of your sales regularly end up as bad debts, you should tighten up your credit checks before extending credit terms.
  You may also want to look into CreditorWatch, a new service that enables small businesses to monitor their debtors, “name and shame” late payers and also be alerted to any other defaults.

2. Refunds

Note: You should be aware of and ensure that your business complies with legal requirements in respect of refunds. Note that in Australia, the Australian Consumer Law applies to both B2C and B2B transactions. There’s an excellent guide available titled: Consumer guarantees: A guide for businesses and legal practitioners. Download it, read it and also get legal advice to ensure your business policies & practices are compliant.

A refund request essentially negates the sale.

Legitimate Refunds
If your business experiences have high rates of refund requests, there is clearly an issue with the quality of your products or services. And until that quality issue is addressed, it would be prudent to incorporate that refund factor against your sales forecast numbers OR against your cash collection. Because that is cash that you will either:

1. not be able to collect if you sold on credit terms; or
2. have to return the money if you sold on cash terms. It’s not part of your “free cash flow” ie money that you can keep for your own use.

“Deshopping”
Outside of refunds arising from legitimate quality issues, there is a disturbing trend called “deshopping” which Tamara King & John Balmers discuss in their article “When the Customer Isn’t Right” on the HBR Blog Network. “Deshopping” is where goods are being purchased with the full intention of returning them with a request for a refund after using them.

This is particularly damaging on the profit line for physical goods. A retailer can’t re-sell a used dress for the full price! King & Balmers provide 4 tips on how to minimise this type of refunds.

In the digital products market such as online coaching programs, where it is standard practice to provide money back guarantees within a stated period (usually 30 days), a certain amount of “deshopping” invariably occurs. There are less-than-ethical people who simply go around buying digital products, getting the information and then requesting a refund at the end of the guarantee period.

If you are in this business, you should not – as a matter of prudence in cash flow forecasting – consider any of the cash collected from the sales as yours to keep until after the guarantee period. In other words, whilst you might have received cash at the time of sale, it isn’t free cash flow for your business until you’re past the guarantee period.

Summary

By getting a good handle on your sales to cash conversion cycle you can better plan your cash flow. The process also helps you identify any other operational issues in your business so you can fix them before they start to hurt your business.