1. WHITE PAPER
Working Capital – the
importance of effective cash-
flow modelling and forecasting
Author: Rob Campbell
November 2011
WORKING CAPITAL
The importance of effective cash-flow modelling and forecasting
Cash is King. This is well known. Working capital is important to businesses of all size, but the owners and
managers of smaller businesses and those in the first phases of start-up can end up living and breathing
issues surrounding cash rather than focussing on the business. The answer is to develop an effective cash-
flow model that is used to support good business decisions and to identify how to keep cash in the business.
The appropriate level of working capital is required to enable businesses to succeed whatever the economic
climate. Being very good at cash management will give a business an additional advantage, whereas poor
cash management can lead to failure. No matter how profitable the products and services are, or how much
is invoiced, the only businesses than can survive and prosper are the ones that maintain enough cash to
keep operations going.
CASH-FLOW as part of BUSINESS PLANNING
There is no set formula for a good business plan. Rather, plans that follow a generic format are likely to miss
some key aspects of the business that are unique. Successful businesses usually do have good business
plans and it is expected that investors or the banks will require a detailed plan when considering loans or
other investments.
Business owners and executives will naturally focus on the key reasons why they exist; the products and
services they offer, their customers, and the profit they intend to make on their operations. Each of these
areas will need focus that is specific to the business, such as plant and machinery, sales and marketing
activities and supply chain and/or logistics. The financial aspects of the business, particularly for smaller
businesses, are often expressed in terms of Profit and Loss accounts and possibly Balance Sheet.
It is extremely important to have a specific focus on cash-flow to identify the working capital requirements
of the business. It is essential to identify the inter-relationship between cash-flow and all other aspects of
the business operation. Accurate cash-flow forecasting will aid good decision making and, more importantly,
will save a significant amount of time and stress. An accurate cash-flow forecast requires a good cash-flow
model, which identifies the key factors that have an impact. With this model, and the identified factors, it is
possible to demonstrate a variety of cash outcomes based on a defined set of assumptions.
CASH-FLOW MODELLING
Cash-flow modelling is different from cash-flow forecasting. Modelling is used to fully understand the impact
of various key assumptions. Whilst some variables will appear to have an obvious impact, it is the extent of
this impact and the sensitivity of the variables that must be fully understood. The overall purpose of this
modelling is to understand the working capital requirements of the business at various future stages, to be
able to build suitable processes and to make good business decisions required to balance cash and
profitability. Above all, effective cash-flow modelling should be used to support management decisions
when considering the launch of new venture, either as a start-up or within an existing enterprise. The model
can be used to test a range of scenarios to. This will provide a clear understanding of the impact on cash
under a range of business conditions.
Atrium Consulting Ltd Working Capital 1

2. CASH FLOW MODELLING
The following five key steps will help to create an initial cash flow model that can be used
to identify working capital requirements based on key assumptions:
1) Identify all sources of cash and expenditure
a) Identify all the sources of cash coming into the business – generally the result of sales together
with loans and investments.
b) Identify the direct (variable) costs associated with the cash inflow – this may be the cost of
production, commission charges and/or interest charges and fees.
c) Identify the main overhead costs, such as staff, premises, communications, travel, professional
fees, marketing etc.
d) Identify any capital expenditure required to setup and run the business.
e) Identify other discretionary expenditure, such as marketing and training.
2) Model the dependencies between income and expenditure
Once all the significant sources of cash-in and cash-out have been identified, any specific dependencies, where
they exist must be modelled. For example, the number of staff required may grow in steps depending on sales
volumes; each increment will increase the staff overhead costs, but may also incur a recruitment fee. Similarly
the cost of raw materials used for manufacture may decrease as volumes grow. The model at this stage does
not need to include payment timings, just the relationship between sources of income (sales), the variable costs
(cost of sales and or production) and fixed cost.
Identify any assumptions made concerning the relationship between discretionary costs and income (e.g.
marketing and sales).
3) Consider the key variables to be used for different scenarios
One important use of a cash-flow model is to experiment with different scenarios. It is therefore necessary to
identify the variables that will define the different scenarios that need to be tested. There may be a number of
simple assumptions, such as sales volumes, profit margins, interest rates etc. Furthermore the variables may
concern the relationship between costs, such as staff numbers and production volumes.
4) Determine the factors that impact on cash-flow timings
The timing of cash-in / cash-out is complex and can be affected by several other variables. Many suppliers will
have standard terms, and it is important to understand what these are, and the scope for negotiation. Similarly
your business will wish to apply terms on your customers. Not all customers will agree to your terms, nor
perform against the terms even if they agree with them. You may therefore have different terms according to
customer type and even have different terms for a range of other factors such as type of product or service,
sales volumes or even geographic location.
It generally not safe to assume that your customers will adhere to agreed terms, and it is certainly unlikely that
many will pay ahead of them. The cash-flow model must be able to accommodate a proportion of customers
paying late – it may even be sensible to build in an assumption of bad debt. The impact these factors have on
working capital will help to assess the level of risk that a business can afford when negotiating contracts and
when offering credit to certain customers.
5) Build the cash-flow modelling tool
This part will require a basic ability to use a spread-sheet, but having identified the key variables and
dependencies and by taking a structured approach this should not be too challenging. The key to creating a
useful model is to ensure that all the variables that have been identified in the previous steps can be modified
in a single field (or single tab). Clearly, particular emphasis must be placed on the timing of cash-in and cash-
out. This will require input cells that can be used to show the impact of different payment / collection terms.
Atrium Consulting Ltd Working Capital 2
Atrium Consulting Ltd Working Capital 2

3. STRATEGIC PLANNING – linking KPIs to cash-flow
The business plan is likely to identify a number of key strategies. Each of the strategies will have a specific
purpose – the business goals. The cash-flow model should be used in conjunction with these strategies to
highlight the impact on capital requirements. As has been discussed, the cash-flow model should be able to
address a number of scenarios. By combining these with the key strategies, the impact of varying results can
be assessed. This is a valuable stage in business planning as it will help to identify some key metrics - or key
performance indicators (KPIs).
Linking KPIs to cash-flow is a powerful method of establishing a sound business, not least because this
creates a deeper understanding of the relationship between key decisions and working capital requirements.
This helps to determine whether the correct KPIs have been identified.
Some strategies may result in negative cash-flow, which can be balanced by cash-positive strategies. By
understanding the interaction between these, and by using the correct KPIs, future cash-flow problems can
be identified early and crisis can be avoided. This requires effective methods to measure the KPIs, which
should be built into the planning process.
CONCLUSIONS
When launching a new venture or changing company strategy it is essential to fully understand working
capital requirements. A good cash-flow model will help to identify the various factors that will impact upon
cash-flow and highlight the relative sensitivities. This, in turn, will allow meaningful key performance
indicators to be identified. Good processes and methods required to monitor the KPIs will provide an early
warning system.
Business owners and managers that are able to accurately identify the extent and length of time that
investment is required will be in a much stronger position and will maintain better control. They will be able
to focus on the support and development of the business rather than being distracted by cash-flow
difficulties. In short, a good understanding of the factors that influence cash-flow is essential for sound
business management.
ABOUT ATRIUM
Atrium Consulting helps businesses develop winning business strategies. We help businesses grow by aligning
sales and marketing activities to the business strategy. Our services include:
 Business Strategy Development
 Business Process Outsourcing
 Sales and Marketing Strategy and Process Development
 Market Research
 Training and Skills Development
Rob Campbell, Managing Director
enquiries@atrium-consulting.co.uk
020 8334 8301
www.atrium-consulting.co.uk
Atrium Consulting Ltd Working Capital 3
Atrium Consulting Ltd Working Capital 3