Why do you need a cash flow forecast?

In business, “cash is king”. Cash flow is the life-blood of all businesses – particularly start-ups and small enterprises.

A cash-flow forecast is an estimate of the amount of money you expect to flow in and out of your business and includes all your projected income, expenses, taxes and capital payments. A forecast usually covers the next 12 months, but it can also cover a short-term period such as a week or month.

Cash-flow forecasts can help predict upcoming cash surpluses or shortages to help you make the right decisions day to day. It can inform tax payment planning, planning for new equipment purchases, identifying if you need to secure a small business loan or if you need to step up your sales.

Here's why you need one:

Get a cash-flow ‘early warning system’

There’s nothing so frustrating as being hijacked by a cash shortfall.

Doing a cash-flow forecast will give you an ‘early warning system’, so your potential shortfalls won’t come as nasty surprises. Knowing in advance when your account balances are likely to be low will keep you from over-reaching at the wrong time.

Pay your suppliers and team members – and yourself

First and foremost, in business you have to pay your people. Staff won’t tolerate being paid late – they have commitments to meet, and will quickly look for other employment. Similarly, suppliers are your life blood – if you don’t pay them on time, your capacity to deliver to your clients will plummet.

And don’t forget yourself – if you neglect your own income, you could quickly lose heart for the work that needs doing. Then who will run your business?

Catch late payers early

One benefit of doing a cash-flow forecast is that you immediately see which of your customers are good payers – and which are not. Not only can you make extra effort to catch those late payers early, you also have a better idea of what to expect if you don’t. Businesses like retailers, who take their payments at the checkout, don’t have these problems. But if you’re the sort of business that sends out invoices, then a cash-flow forecast will be invaluable for spotting the slow payers – and doing something about them.

Get loans easily

If you don’t have a cash flow problem – great! A cash-flow forecast will still be invaluable. There could come a time when you need to make a big-ticket purchase – another Big Mack for your fleet, fitting out new premises, or a major technology upgrade. A cash-flow forecast will make applying for a loan far simpler – the lender will be able to see that you can comfortably service the loan. For a really big chunk of money, your bank might want to have regular looks at that forecast for the life of your loan – so keep it updated.

Set goals and stay focused on them

Setting business goals is the key to success – it means you’ll consistently pull in the right direction, and aren’t as easily distracted by shiny (but irrelevant) opportunities. Use a cash-flow forecast to set your targets and you’ll have a better chance of hitting those targets. Why? You’ll have your financial goals clarified, and be able to see instantly how well you’re tracking.

And that will help you stay focused – should I buy that laptop now, or keep using this one for a while longer? Should I outsource this work so I can focus on other things, or is it best to keep it in house this month? Is that new opportunity something that will move me closer to my goals, or is it a distraction?

Having those goals top of mind will mean you make better, smarter decisions day to day.

Preparing a cash-flow forecast

Cash-flow forecasts sound easy to prepare, but they need to be accurate and comprehensive. Consult an expert like an accountant, so you know you’re not missing anything, and you’ve got all your sums correct

Here’s how you – or your accountant – can prepare your cashflow forecast.

Estimate your likely sales

Using your previous sales history over a couple of years, estimate your likely sales for each week or month. Be sure to include seasonal patterns and one-off events such as trade shows in your projections.

If you've just started a business, estimate your forecasts based on information from customer surveys, suppliers or industry experts.

Factor in your future plans, current market conditions and trends. Put increased sales expectations into your forecasts if you're planning a new marketing drive or launching a new product. If a competitor has entered the market, drop your forecast figures a little to allow for the possibility that they might gain some of your market share.

Estimate your payment timing

Estimate when you expect to receive payment for your sales. This will be easy if you deal in cash sales only. If you sell on credit you'll need to factor the likely delay in payment.

Take how much income you expect, and when you expect it, and put these figures into your cash flow forecast.

Estimate your likely costs

Fixed costs are what you have to pay regardless of sales, and include rent and salaries. Variable costs vary – usually according to sales. For example, you don’t pay delivery fees for stock if you didn’t order any.

Use your forecast sales levels to work out the amount of stock or raw materials you'll need to buy in to meet your sales figures. Identify from historical payment records other bills you'll need to pay and when you'll need to pay them.

Add the payments you need to make, and when, to your cash flow forecast.

Don’t forget capital payments and taxes

While sales and costs form the core of your cashflow, it is also important to remember any capital payments and taxes that you have to pay.  This includes loan payments, hire purchase payments, GST payments and income tax payments.  Your tax payments are less often than most of the other payments that go through your business so they are often the items that get forgotten.  If you want to check that you have everything in your cashflow, we recommend that you go through the last couple of months bank statements line by line and you will quickly see anything that you have forgotten.

Use your forecasts

Now your cash flow forecast is ready to use. To check your likely cash position, enter an opening bank account balance, and add the revenue less the expenses, capital and tax payments for each weekly or monthly period.

We also recommend that you enter your cash flow forecast into your accounting software so that you can quickly and easily track at any time how your actual results are tracking against your forecast position.

Your forecasts are only useful if they are accurate and up to date, so regularly update them against your actual business performance. That way, you know your information is accurate, and you can adjust future forecast figures as soon as you see they're likely to not be as expected.

Get a better handle on your business

There are so many benefits to your business when you develop a cash flow forecast and keep it up to date. It’s a good ‘early warning’ to keep you from spending what you don’t have, it helps you pay your fixed costs on time, and identifies late-paying customers. When you need a loan for that big-ticket item, your forecast will help satisfy the bank, and you can more easily meet your goals when you know what your financial position is likely to be.

It might take some spadework to establish, but a cash flow forecast will be worth the time you invest, now and in the future.

Need help developing a cash flow forecast for your business? Talk to the experts at Thrive CA today.