Cash flow forecasting

What is a cash flow forecast?
A cash flow forecast is essentially an educated guess of your incomings and outgoings. It is used to determine how much cash you have available at any one time and to help you plan ahead so you aren't hit by any unexpected shortfalls.

A cash flow forecast is not the same as cash flow tracking. While both are important, cash flow tracking is a literal record of what payments you have made and what payments you have received, whereas forecasting is the projection of your cash flow for the coming period.

Cash flow tracking can be extremely useful in establishing your forecast. Using figures from your cash flow tracking you can calculate a tally of where your money will come from and where it will go. It can be used for a short-term and long-term outlook.

If you are only just establishing your business, your cash flow forecast can also be used to write a business plan. By using estimated figures you can project the incomings and outgoings for financiers or investors.

Why do you need one?
A cash flow forecast helps you maintain a strong cash flow by alerting you to issues before they occur.

To be successful in business you need to understand the cash flow cycle of your organisation. That is the time between income and payments relative to your business operations. The cash flow cycle is repetitive and should be as short as possible. With a short cycle, your business can operate on less money as cash is regularly coming in to cover outgoing payments.

A cash flow forecast can prepare you for patterns in the cycle when you expect costs to be higher or income to be lower. These patterns are generally marked by large expenses or a quiet trading period. By identifying these patterns you can prevent a cash shortage by ensuring you have enough working capital available to cover your expenses.

While cash flow forecasting is not an exact science, particularly if you're using estimated figures, it can give you a good idea of where your cash flow will stand. However if you track your cash flow, and have for some time, your forecast will be more accurate at a given point in time.

How can you create a forecast?
Tackle your cash flow forecast one period in advance. It is recommended you prepare three, six or 12 months at a time and that you set time aside each month to review and fine tune your forecast. However it's important to remember that it is only a forecast so if your situation changes you can adjust the figures as necessary.

These simple steps will help get you on your way to an effective cash flow forecast:

Step 1: Project your expected sales for the month. Using your actual sales figure from the previous corresponding period as a guide (for example for December 2010, use the figure from the previous December), as well as the market climate and seasonal trends, enter what you believe your sales figure will be for the month.

Step 2: Tally your expected incoming and outgoing payments each month. Be sure to include annual expenses like insurance. The list below will help give you an idea of the kinds of payments to include:

Incoming payments

  • Customer payments (payment of invoices, debt collection)
  • Sale of assets (property, equipment)
  • Investment income (interest, dividends)
  • Sundry income (tax refund, unusual business activities, supplier refunds)

Outgoing payments

  • Expense payments (paying invoices - weekly, monthly, annually)
  • Employee payments (hiring costs, payroll - salaries, leave, bonuses, overtime)
  • Purchase of assets (property, equipment)
  • Investment expenses (interest)
  • Sundry payments (litigation, tax, donations).

You should also differentiate between cash and credit for customer payments as this will reflect when you actually get paid. Cash sales should be considered immediate sales however credit sales will be delayed and should be entered when you expect payment. Also, take into account your customers payment histories - you don't want to be relying on payment from an undependable customer to be able to pay your own accounts.

When making estimates on the amounts, be liberal. It is better to predict that you will sell less or outlay more and be pleasantly surprised each month. If you are unsure how to estimate the figures (particularly if you are new to running a business), do some research. Look at industry or business forums, speak to other businesses or ask an accountant with experience in your line of work.

Step 3: Calculate the net difference (subtract the outgoings from the incomings) to show if your cash flow is positive, negative or drawing even.

Step 4: If you begun your cash flow management process with a forecast rather than starting with cash flow tracking step four will allow you to see whether your forecasts became a reality.

As the months pass, you can compare the forecast to the actuals - this will help with creating your forecast for the corresponding period in the future.

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