Cash flow forecasting

February, 2011

Take control of your cash flow by using a forecast. Poor cash flow marks the failure of approximately 90 percent of small businesses - don't let your business become a statistic.

To secure a strong cash flow for the life of your business, it is important you have good control over your incomings and outgoings. To prepare for the ups and downs and ensure you have cash to pay your invoices on time, you need a plan - a cash flow forecast.

A cash flow forecast is essentially an educated guess of your incomings and outgoings. It is useful in maintaining strong cash flow by predicting how much cash you have available at any one time.

Firstly, it is important to recognise the difference between cash flow forecasting and cash flow tracking. Although 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, however it is not essential.

Using estimates or real figures from cash flow tracking, you can calculate a tally of where your money will come from and where it will go in the short-term or long-term. If you are only just establishing your business, use the projections of your cash flow forecast to write business plan.

Before you start, gather a full understanding of a cash flow forecast and what it can do for your business.

The Benefits of a Cash Flow Forecast

Using a cash flow forecast can have a number of benefits for your business. It can:

  • Provide a rough idea of where your cash flow stands. It is not an exact science (particularly if you're using estimated figures) but the longer you have been tracking your cash flow, the more accurate your cash flow forecast will be.

  • Help you understand and improve the cash flow cycle of your business (the time between income and payments). The cycle should be as short as possible as this will result in greater profits and reduced costs.

  • Assist in preparing for patterns in your cash flow cycle. Cash flow tracking can help you identify patterns of high expenses or low income (months with large annual expenses or a quiet trading period). Using cash flow forecasting, you can prepare for these times by ensuring you have enough working capital available to cover your expenses.

Step by Step

To create a useful forecast, you need to tackle your cash flow month by month. The easiest way to keep your forecast organised is to use a spreadsheet, so it is straightforward to make changes as needed.

For a short-term outlook, take it one month at a time and set time aside each month to complete the coming period. However, if you are looking for a longer-term outlook, you can do three, six or 12 months at a time. Remember that it is only a forecast, so if your situation changes, you can adjust the figures as necessary.

Use these steps to help create a cash flow forecast for your business:

Step 1:  Project your expected sales for the month. Using your most recent monthly sales figure, in conjunction with your industry knowledge of seasonal trends and market climate, enter what you believe your sales figure will be for the month.

Step 2:  Tally your usual incoming and outgoing payments each month. Be sure to add in all payments including small things like stationary and annual expenses like insurance. Use this list as a guideline 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)

Also be sure to differentiate between cash and credit for customer payments because this will affect when you will actually get paid. Cash sales will be considered immediate sales however credit sales will be delayed and should be entered when you expect payment. Similarly, you should take into account your customers payment histories - you don't want to have to rely on a payment from a customer with a chequered payment history.

When making estimates on the amounts, be liberal. It is better to predict you will sell less or outlay more and be pleasantly surprised each month. Doing some research on common costs will help if you are unsure of how to estimate the figures (particularly if you are a new business). Spend some time on industry or business forums, speak to other businesses or ask an accountant with experience in your industry.

Step 3:  Calculate the net difference (subtract the outgoings from the incomings) to determine if you are positive, negative or drawing even.

Step 4:  As the months pass, you can change the figures to actual amounts. Not only will this enable you to see how your estimates fare against reality, but you can also start tracking your cash flow. It will make it a lot easier to revise your forecast for the period.

It is important to understand that a cash flow forecast will help you manage your cash flow but it is not full-proof. Make sure you are prepared for a cash flow shortage - read Short on cash? >>

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