A cash flow forecast offers valuable information about your business’ expected future performance. By understanding how much cash the business is likely to have over a set period of time, you can make informed commercial decisions about investments, expansion or even determining the future viability of your company.
What is a cash flow forecast?
A cash flow forecast is an estimate of the amount of cash that will be coming in and out of a business over a defined period of time. In cases where you predict more cash coming into your business than you will have leaving it during this period, this is referred to as positive cash flow. If, on the other hand, the opposite is true, where there is likely to be less cash coming into your business than you have leaving it, this is referred to as negative cash flow.
Importantly, there are key differences between cash flow and profit. Cash flow is essentially the money flowing in and out of your business throughout a defined period, whereas profit is whatever remains from your revenue after deducting costs. Although profit is usually used to indicate the immediate success of a business, cash flow is an effective way to determine its overall health at any given time. This is because a business can be profitable while still suffering from poor cash flow. For example, for a small manufacturer selling wholesale products to large companies, a late payment from a single customer could result in it being unable to pay its suppliers. This means that even if you have a successful product with increasing sales, you could end up facing cash flow issues nonetheless and, despite achieving profitability, your business might be unable to meet its own financial obligations.
As a business owner, it is vital that you understand cash flow and how to manage it, as any failure to do so can easily contribute to the failure of your business. This is because your cash flow position directly impacts the amount of money available to fund the day-to-day operations of your business, otherwise known as working capital, where a sustained period of negative cash flow can make it extremely difficult to pay staff and suppliers either on time or at all, or cover other essential expenditure. This could include, for example, fuel costs, commercial lease costs, utilities and tax liabilities. In short, if your business lacks the cash to cover important things like wages, rent and other monthly bills when these fall due, it will struggle to stay afloat, even in the best of times. If you combine a lack of cash with uncertainty around the economy, the survival of a business can be even more challenging.
Why are cash flow forecasts needed?
Also known as cash flow budgets or cash flow projections, a cash flow forecast is a practical tool to help ensure that your business has the cash it needs to be able to function. However, in addition to routine budgeting in the context of running the business itself, there are a number of reasons as to why a cash flow forecast may be needed, including in times of change. This could be, for example, where a business has lost a major customer, a customer is late in paying a large invoice or may not pay at all, cheaper alternatives have entered the market, the prices of stock or raw materials has risen, or there has been a general downturn in consumer demand and trading conditions. However, being able to adapt to change, however this may come about, is often integral to the success and survival of a business.
By undertaking periodic cash flow forecasts, this will help you to identify where cutbacks may need to be made to ensure the survival of the business. It can also be used for the purposes of renegotiating with suppliers and customers. Equally, for any businesses in need of finance to help resolve their immediate cash flow problems, any lender or investor may be keen to assess the financial position of the business over the coming months.
Finally, even for those businesses who are not in financial trouble, but looking to expand their operations, a cash flow forecast can either be used to assess affordability or to persuade any lender or investor of the financial health of the business. In this way, the forecast can be used to help free up or raise working capital to facilitate growth.
It is worth noting that the growth of a business will often rely heavily on available cash, for example, a business must carry sufficient stock in order to grow, but increased sales will not always equate to cash immediately coming back into that business where customers benefit from deferred payment terms. Having a clear view of the working capital available to your business will put you in a much stronger position when deciding what action you need to take, whether this be to reduce debt or fund new opportunities. As such, the biggest benefit to creating a cash flow forecast is greater clarity, giving you clear insight into the likely future state of your business based on current estimations.
How to create a cash flow forecast
Below, we have set out four simple steps to be able to build your own cash flow forecast, although it is always best to seek expert advice from a qualified accountant:
Decide the forecast period
Cash flow planning can cover anything from a few short weeks to several months, where the period will often depend on the purpose for which the financial forecast is required. However, as the general purpose of a cash flow forecast is to illustrate how much money is likely to be going out and coming back into your business over a certain period of time, you must ensure that it covers a period that is at least as long as your cash flow cycle. This is the amount of time that it takes for cash leaving your business to come back in.
For new businesses, there may not yet be sufficient data to base predictions on, where the further ahead you try to forecast, the less likely it is that this will be accurate. If you cannot plan far ahead, this is not necessarily any cause for concern, although you will need to do more regular forecasts to keep abreast of any changes, including things like how well any product sells or how much any utility bills will be. Over time, you can start to measure actual cash flow against cash flow forecasts to determine whether your business is meeting its predicted targets, becoming more accurate each time. Even with more established businesses, regular forecasting can also be a good way of preempting any unforeseen issues.
List all your business income
Having decided on the period over which your forecast will be set, for each week or month within that period you should itemise all the cash that will be coming into the business. Staring with your customer sales, you should have one column for each week or month, and one row for each type of income, adding these figures to the appropriate column and row. Most businesses will take advantage of using a computerised spreadsheet to make this task easier. This can also be used to create a cash flow template for future forecasts.
When inserting figures, care must be taken to be realistic, where this is all about when the cash is likely to land in your business account, so not only including when clients are due to settle invoices, but when those payments will clear. It is important to remember that cash flow forecasts are only as reliable as the assumptions you make and the data that you use. If the data that you input is inaccurate, your forecasts may be way off mark. You may be able to predict figures for your current forecast from any previous forecast, for example, from last quarter’s or last year’s figures, but only if nothing has noticeably changed.
You must also remember to include all non-sales income, such as any anticipated tax refunds, business grants, capital from investors or shareholders, or external finance. Having listed all the income, you can then add up each column to provide a total for that period.
List all your business outgoings
Now you know what is coming into your business, you will need to work out what you have going out. For each week or month, make a list of all the money you will be spending. This can include salaries; raw materials or products purchased from suppliers; rent or mortgage for commercial premises; utility bills, including water, gas and electric; public liability and any other insurances; any assets needed to run the business, such as computer equipment or vehicles; bank loan repayments and fees; the cost of marketing and advertising; and tax.
Only once you have listed all of the outgoings for your business can you add up the total, although the type and amount of outgoings can vary significantly from business to business.
Work out the running cash flow
For each week or month column, you will need to take away your net outgoings from your net income to get your cash balance. This will give you either a positive cash flow figure, where you predict having more cash coming in than going out, or a negative cash flow figure, where you predict spending more than you have coming in. You can keep a regular running total of your net cash flow to get a clearer picture of your forecast over time. Each time that you conduct a cash flow forecast, you will also need to take the closing balance from the previous period, providing you with the opening balance for the following period.
Importantly, where you anticipate sustained periods of negative cash flow as a result of your cash flow forecast, proactive steps will need to be taken in advance to ensure that you have enough available cash to be able to meet the everyday needs of the business.
How to improve your cash flow position
If, having created a cash flow forecast for your business, you find that the business has negative cash flow, there are ways to improve this. Although every business is unique, there are a number of ways in which to bolster your cash position, including:
- manufacturing stock as quickly and efficiently as possible to facilitate increased sales, while also limiting the number of write-offs or quality-control issues
- managing unsold goods and stock as effectively as possible, helping to release any cash that may be tied up in inventory
- improving the process used in your business for chasing up and collecting payments from debtors, helping to make sure that your customers pay on time and in full
- reducing the period of any deferred payment terms to the fullest extent available without this damaging relationships with customers, for example, from 60 to 45 days
- increasing credit terms from suppliers, again to the fullest extent available without this damaging these working relationships
- renting rather than buying any equipment or vehicles needed for your business outright.
In addition to making simple changes to help improve cash flow, there are also a number of different financing solutions available to businesses that can help to resolve any immediate cash flow problems, from traditional bank loans to invoice finance. For example, invoice finance, is where a business is able to sell unpaid invoices at a discount, or use these invoices as collateral for a loan, in either case receiving an immediate cash advance on a significant percentage of the value of those invoices. You could even look into raising cash by selling and leasing back business assets, such as any machinery and equipment.
However, in uncertain times, where cash flow is proving to be a problem for your business, it is always best to seek independent advice. Importantly, you must never ignore a predicted cash shortfall, where steps must be taken in advance to address any potential problems with working capital before these hit the business and threaten its survival. Armed with this clarity and knowledge, and with the help of a financial expert, you can make important decisions about the running of your business before these issues become critical.
Cash flow forecast FAQs
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Legal disclaimer
The matters contained in this article are intended to be for general information purposes only. This article does not constitute legal or financial advice, nor is it a complete or authoritative statement of the law or tax rules and should not be treated as such.
Whilst every effort is made to ensure that the information is correct, no warranty, express or implied, is given as to its accuracy and no liability is accepted for any error or omission.
Before acting on any of the information contained herein, expert professional advice should be sought.
Author
Gill Laing is a qualified Legal Researcher & Analyst with niche specialisms in Law, Tax, Human Resources, Immigration & Employment Law.
Gill is a Multiple Business Owner and the Managing Director of Prof Services Limited - a Marketing & Content Agency for the Professional Services Sector.
