It’s no secret that many small businesses suffered from negative cash flow thanks to the crushing effects of the COVID-19 pandemic in 2020. In fact, the 2020 cash flow hiccup could still have harsh consequences, as it may affect small business’ ability to borrow money, plan for a new product launch or create an effective, forward-looking business plan.
As your business recovers from the pandemic, now may be a good time to implement a little-known accounting technique called predictive accounting. Predictive accounting typically utilizes AI software to analyze the ebbs and flows of your company’s past cash flows to reasonably predict how your company will financially perform in the future.
“Cash flow-based lending using predictive analytics is becoming more popular as technology improves and predictive cash flow data becomes more readily acceptable,” said Nick Chandi, CEO and co-founder of ForwardAI, a financial technology company for small businesses. “After all, in addition to a business owner’s credit score, shouldn’t a primary concern be their continued ability to service loan payments? A loan application that includes a cash flow forecast and a prepared plan for what to do with the funding they receive will impress any small-time lender.”
Why is Predictive Accounting Important?
Predictive accounting can be used to help your business in a variety of ways. First, it can make your business operate more efficiently. By analyzing your past cash flows and reasonably predicting future results, it can help you create a more sophisticated future business plan for your company.
Predictive accounting can assist you in identifying
- Future cash situations.
- Upcoming business challenges, including cash flow gaps.
- Potential monthly cash inflow/outflow.
- Financial trends, and
- Automated accounting and banking data comparison.
“Predictive accounting is based on the observation of how much managerial work can be repeatable,” said Stephen Curry, CEO of eSignature company CoCo Sign. “Also, it projects future financial performance utilizing a significant statistical understanding of your company’s processes. It mainly allows for management assessments in terms of accounting-oriented characteristics.”
Curry also emphasized that predictive accounting can reasonably predict which areas of your company you will need to focus more heavily in the years to come based on your company’s past financial performance.
“The key to predictive accounting in creating a 3-year business plan is to focus management on the future instead of the past,” he added. “Using this, you will be capable of pulling details from various systems, and it can improve forecasting, which means you can create a better long-term plan, which directly impacts the customer response time, experience, revenue, and faster decision-making.”
Predictive Accounting can Help in Financing
Today, traditional and alternative lenders have to make judgement calls on whether to do business with SMBs, since many suffered from negative cash flows in 2020. Some lenders may want to see a three-year revenue history to make sure that 2020 was just a financial anomaly, but some may want to get an idea of how your business will do going forward to determine your company’s ability to pay back a loan.
This is where forward-looking accounting using sophisticated AI software can help you. With it, lenders can get a good idea of what your cash flow may look like in the future, based on historical accounting data, thus strengthening your case when you’re seeking financing.
“Future financial health is a crucial data point for lenders to understand how likely it is that a borrower will successfully complete their loan,” said Chandi. “Since cash flow is the strongest indication of a company’s continuing viability, it makes sense that projected cash flow would be an important metric for anyone interested in small business loans.
“While account statements and tax returns show you the past, predictive cash flow gives you critical insight into a prospective borrower. It’s not guesswork, either. Cash flow forecasting technology is a methodical invention built with innovative technology.”
Organize Your Business for Years to Come
You can use predictive accounting to divide your business into different categories and year blocks and then separate all the cash and other resources available to your business over the next X amount of years. This can give you an idea of how much of your resources you should be allocated to each segment of your business in the coming years.
Put simply, when you, the SMB owner, decide what areas of your business to spend money on in the coming years, your decision shouldn’t be based solely on historical data, rather, it should be based on rolling financial forecasts.
“You might decide that half your resources will be used up in building a new factory for producing widgets,” said Lynda Fairly, cofounder of Numlooker, a New York-based small business specializing in providing reverse phone number lookups. “You might decide another quarter will be used on marketing your product line.
“And another quarter on developing new products and improving existing ones, etc. Once you have determined precisely how much money is available for each area in each year, you can then determine how much profit will be generated.”
“Again, using a process of predictive financial modeling, you can develop a sales forecast and profit forecast for the next three years. Once you know what your surplus cash will be in each of the next three years, you can then allocate this surplus to specific projects by breaking it down into smaller chunks.”
I’m Not an Accountant – How Can I Use Predictive Accounting?
If your small business uses an accountant, he or she should be able to provide predictive accounting as a service and be able to advise you on how best to use it in planning your business going forward or to get financing. If you do not have an accountant, you probably should consult with one. There are also plenty of affordable accounting software packages that may be able to help you.
Some of the most popular accounting software packages are Sage Intacct, Oracle NetSuite, FinancialForce and Epicore Financial Management. Whichever one you choose, however, you must understand that predictive accounting is a complex process. It may be in your best interest to at least get advice from an accountant to see how it works and how it can help you.