Cash flow forecasts – how to use them

One of the major causes of failure for any small business is poor cash flow – in basic terms, more money is going out of the business than is being received. A business can be very profitable on paper but, if there is no money to pay the bills, then it will be forced to close. The personal, emotional and legal consequences for the business owner can be immense. Cash flow problems cannot always be solved but, if they can be anticipated in advance, some of the worst consequences can be mitigated and alternative plans put in place. This is why preparing a cash flow forecast is important for your business.

A cash flow forecast is an estimate of sales income and expenses, based on when that income is expected to reach your bank account and those expenses paid out. Income projections are not based on when customer invoices are due (although when accounts’ receivables are under control this might be the same thing), but on the date you actually expect those invoices to be paid. Expense forecasts similarly reflect the date supplier invoices must be paid, not when they are received.

Cash flow forecasts allow you to predict your business’s future financial position for the period ahead, be it 3,6 or 12 months. The further out you are forecasting though, the less accurate you can expect your forecast to be, because of all the future unknowns that may arise.

A cash flow forecast allows you to predict and account for any seasonality in your business and plan accordingly. For example, a typical retailer might expect to have high sales in the period before Christmas and then a slump in the early part of the following year. By comparison, a company which sells swimwear and beach accessories would expect most of their trade during the summer months. And, whilst those sales might come in one month – in the examples above, December or July and August, the stock needed to make those sales might have to be paid for in January, for instance, or September. Without forecasting this properly, you might be tempted to spend all the money earning during the peak periods, and have nothing left to pay your subsequent costs.

Cash flow forecasts can be created via Excel spreadsheets, through computerised accounting software, or from templates which can be downloaded for free. You may want to enlist the help of your accountant or financial adviser to help prepare your forecast for you but this does not abdicate you of responsibility for it. Even if somebody else prepares it for you, it is your duty to understand your cash flow forecast and takes the necessary decisions based on it.

A few basics before you start. Firstly, we recommend that the forecast is based on a monthly basis. You can do it by day, by week or by quarter, but because most supplier invoices have payment dates specified by month, and your customer invoices are likely to be issued on similar terms, monthly is the normal forecast period, with most forecasts comprising a number of months ahead. Also, if you trade in foreign currencies or have bank accounts denominated in different currencies, nominate just one currency as the main one for your business, and prepare all income and expense forecasts in that currency. Unless you are an experienced foreign currency trader, don’t try and forecast future foreign exchange rate movements! Use today’s exchange rates.

The first step in preparing your cash flow forecast is to enter the amount of cash that you have on hand now – this will include the amounts held in bank accounts and any significant cash balances held.

Then identify what money will come into your business in the months ahead. This could be money from sales you have already made in the form of outstanding customer invoices, and projections of future sales based on past performance or market research. Remember only forecast what you actually expect to receive from customers, not how much you expect to invoice. Prudence should definitely be exercised in this area, as late payment of supplier invoices is endemic in many countries, with large companies the worst when it comes to settling with their suppliers.

Now record all the expenses you expect to pay in the forthcoming period. This should include all variable and fixed costs, taxes and similar payments like VAT, bank charges and interest payments, as well as any drawings that the owner is likely to make from the business. Again remember to forecast supplier payments when they are due, not by their invoice date.

Add your income to your opening bank balance, subtract your expenses, and you have your projected bank balance at the end of the period. Repeat this each month and you will have an understanding of your business’s likely cash flow position for the period ahead. Cash flow positive at the end of the month – good. You have enough cash flowing into your business to meet your expenses with, hopefully, some surplus left over. Cash flow at the end of the month negative – bad. You will need to find additional finance to keep your business going, or will need to increase sale, decrease costs or both.

Cash flow forecasts should be updated each month based on actual business performance and changes to business conditions and projections. Your initial cash flow forecast may have been too optimistic or conservative – be prepared to adjust it accordingly.

Apart from providing a good indicator of your likely cash position at any point in time and acting as a barometer of future cash flow problems, a forecast also helps you plan for projected events.

If you plan to open a new shop or introduce a new service, you can include the upfront launch costs into your forecast, and then see what impact the additional income, and associated expenses from it, will have on your business. The more sophisticated may consider preparing worst case, a bast case and neutral version of the forecast to determine how robust the returns from the new venture are likely to be. If the projected returns from the best case scenario look very optimistic compared even to the neutral version of the forecast, probably best to defer the new launch until your cash flow position is stronger.

Your cash flow forecast gives you a future view into your business. It helps you anticipate cash flow problems before they materialise, develop alternative strategies, and help you plan for the future. In short. it allows you to make better, and more informed, business decisions.





Leave a Reply