A cash flow forecast is an important part of your business plan: it shows what money you have coming in and going out of your business. This article gives you some practical advice to help you forecast cash flows and options for improving your cash position.

Who will want to see cash flow forecasts?

In the main, cash flow forecasts are used internally by a business to:

  • understand their financial position
  • identify any potential cash shortfalls
  • ensure they have enough cash to pay suppliers, employees, etc.

However, if a business finds itself needing a loan, then the bank will request a detailed forecast of future cash flows before considering lending the money.  If a business’ cash flow forecast shows negative cash flow for an extended period of time then it is unlikely that a lender will accept the business for a loan on the basis that they are unlikely to be able to satisfy loan repayments when they become due.

Other parties considering investing in a business may also request sight of the cash flow forecast as a way of checking the health of the business that they are planning to invest in.

How can I improve cash flow?

Cash flow can be improved through planning and organisation.  A business that has a clear understanding of when cash is due in and out of the door will be able to manage their cash flow better.

Actions to take

Forecasting - As detailed above, cash flow forecasts require a business to consider their monthly income and expenses and plan for these going forward. 

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Forecasting

Once income and expenses have been identified by a business and actual payment and receipts have been forecast this information can be used to highlight issues and target any areas for improvement.  This may include chasing up any customers that consistently pay late or negotiating longer payment terms or discounts with suppliers.

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Monitoring - A business should monitor its cash flow against the forecast and identify any causes for variances. 

 

 

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Monitoring

If cash inflows are a lot lower expected it may be that there is an error in the sales assumptions.  Similarly, if outflows are higher than anticipated then one or more expenses may have been overlooked.

A thorough understanding of the costs, revenues and timescales associated with running your business will lead to improved cash flow and the ability to make decisions based on this.

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How do I forecast cash receipts?

A cash receipt is an amount of money received by a business from a source which could be a customer paying for goods or services, interest on investments, additional funding paid in by the owner etc.

In order to forecast these receipts a business needs to understand their sources of income. 

Sales Income

A sales forecast is prepared to identify the value of goods or services that a business expects in a given period.  This forecast shows when sales are a made and/or services are provided, whereas a cash receipts forecast involves considering when the money for those sales is paid by the customer. 

By using this sales forecast, along with details of the credit terms offered to customers, you can begin to forecast cash receipts.

If a business allows customers 30 days to pay for goods/services from the invoice date then the cash receipts forecast will show funds coming in to the business the month following the provision of services/sale of goods.  If a variety of credit terms are offered to different customers then this needs to be taken into account.

Also it is worth considering that although a business may offer certain credit terms, there may be specific customers who always pay early or late.  Looking at previous sales and payment records will help to identify any of these and help a business to build this into their cash receipts forecast.

Also note that if the business is VAT registered then the sales forecast will show income exclusive of VAT, whereas the cash receipts forecast should show income inclusive of VAT as this is the value that the customer will be paying.

Non-Sales Income

Income from sources other than sales may include bank loans, interest and rent received.  As a small business owner you should consider these additional funding sources and identify if any are relevant to you, using best known information to record when you expect to receive this cash.

Regular monthly receipts may be easier to forecast, but be sure to consider any one off receipts that may be expected.

How do I forecast cash payments?

To forecast cash payments a business must consider all costs that relate to its operations.  

What does this include?

Direct Costs - After forecasting sales, a business needs to consider the cost of producing the goods or supplying the services to meet that level of sales.  

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Direct Costs

Looking at historic data such as supplier invoices or reviewing contracts will help a business to identify what these costs are likely to amount to for the required quantity.

Similarly to forecasting cash receipts, a business needs to consider the amount of time from receiving an invoice to making a payment by taking into account the credit terms that are offered by suppliers.  If purchases are made using a business credit card the payment date of statements should be used within the forecast.

If payment discounts are offered by suppliers for quick payment then a business can use this forecasting process to help identify whether their financial position is adequate to take advantage of these.

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Indirect Costs - Some indirect costs may be paid on a monthly basis, such as rent and reviewing bank statements should help a business to identify and forecast these cash payments fairly easily. 

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Indirect Costs

Other expenses may be more ad hoc and can be harder for a business to forecast.

Reviewing previous months’ expenditure will assist with identifying payments, and analysing upcoming business activity can highlight any exceptional costs that may be incurred. 

It is important to be realistic when forecasting for future cash payments as understating these may only lead to cash pressures on the business.

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Can software help with this?

There are many different online tools, apps and software packages designed and developed to help a business with tracking and forecasting cash flow. These will vary in price and complexity so they may not all be suitable for small businesses but can be easily searched for online.

Software will help you present and store your cash flow information, however a business will still need to understand their cash inflows and outflows in order to make use of such software.

Spreadsheets may be useful tool to assist with cash flow forecasting as information can be entered, modified and presented clearly in a simple report format.  Various functions within a spreadsheet allow users to automate some of the forecasting process and create 'rules' around the treatment of various cash flows. If you use Excel, the 'goal seek' tool is a useful function. 

For example, if Customer A always pays for goods within seven days of being invoiced then that anticipated sales value can be taken from the sales forecast and recorded within the cash receipts expected 7 days from the sales date.  A formula could be used to find any future forecast sales to Customer A and automatically enter that value as cash inflow seven days later.

Many laptops and computers are purchased with spreadsheet software already installed and users can find a wide range of websites offering free information and tutorials on how to make use of the functions that exist within these. 

To read more on cash forecasting and to download a cash forecast template click here.

What does insolvency mean?

Cash flow forecasting is so important because if a business runs out of cash and is not able to obtain new finance, it will become insolvent.

Insolvency is a term that refers to when a business, or individual, is unable to meet its financial obligations (ie pay its bills) when they become due.  This is more frequently referred to as bankruptcy for individuals.

Insolvency happens when:

  • the total value of a business’ liabilities exceed that of its assets
  • a business’ current and future debts are unable to be paid. if whether your business has run out of money.

Insolvency law details the steps that are taken when a business becomes insolvent.

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Read more on cash forecasting and download a cash forecast template

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