A cash flow forecast is a document that will help you to estimate the amount of money flowing into and out of your business. It includes income and expenditure projected over a 12-month period. However, you can do it over longer periods – 2 or 3-year time spans being the most typical.
You’re going to need one in order to convince potential funders that they are going to get their money back. With that in mind you need to make sure the information is as accurate as possible and that the modelling is clear.
Click here to find out more about cash flow management
Let’s run through the main information you need to know about developing a great cash flow forecast.
- Why you need cash flow forecasting
- Types of cash flow forecasting
- Templates
- 6 Steps to creating a winning cash flow forecast
- Avoiding cash flow nightmares
Why do you need a cash flow forecast?
It’s important to be able to manage what cash is flowing into and out of the business so that you always have sufficient funds for operational needs. Cash flow forecasting helps you to predict cashflow and anticipate any periods of difficulty and therefore take the steps needed to ensure business continues.
You can identify potential shortfalls in cash, ensure that you can pay suppliers and staff, spot problems with customer payments and provide a regular forecast for external stakeholders such as banks or other lenders.
It will help you to manage your liquidity and ensure that your business has the cash needed to meet business goals and avoid funding issues.
Types of cash flow forecasting
There are two ways of cash flow forecasting – direct and indirect
Direct cash flow forecasting: this is used to determine short term liquidity and aims to show cashflow over a specific time period. This focuses on upcoming payments and receipts over a day, week or month timeframe – normally over a 90-day period.
Indirect cash flow forecasting: This derived from various projected statements of income. You can use one of three methods to undertake indirect cash flow forecasting; adjusted net income, proforma balance sheet and the accrual reversal method.
Adjusted net income is derived from operating income and its relationship to balance sheet changes including accounts payable, accounts receivable and inventories.
The proforma balance sheet looks at your projected balance sheet cash account at a future point in time. If all your other balance sheet accounts have been projected accurately, cash will be too.
Accrual reversal uses statistical analysis to reverse large accruals and calculate cash movements for specific periods of time.
Templates
There are a number of templates and tools available on the Web to help you with cash flow forecasting. We don’t recommend any one over another. Here’s a brief list:
The simplest method of creating a cash flow forecast is to develop a spreadsheet in Excel. There are various tutorials online that will help you to do this.
Steps to creating a winning cash flow forecast
You can keep a track of spending and income from customers.
- Create a list of assumptions
You need to go for clarity when you are putting together your forecast. You need a clear rationale so that the assumptions are based on. Assumptions include income and expenses, inventory and accounts receivable. Keep them conservative and reasonable.
- Prepare anticipated sales income
Look at past sales figures and identify trends and seasonal variations. This can give you an idea of how you might perform in the forecast period. Consider products and services that you are selling and conduct some market research to determine the likely uptake. Add in any new products or services that you expect to deliver.
- Prepare a list of other anticipated income
List any additional income that you expect to receive. This could include funding from other sources, sales of assets, interest from bank accounts, rental income due to the business or money put into the company from personal sources.
- Develop a profit/loss forecast
This part of the forecast will consider income to the business combined with day-to-day running costs which gives you an idea of future profit.
- List of estimated expenses
These should be included in the month that are incurred. Cost factors may include staff wages, raw materials and inventory, delivery, packing, IT hosting, software, professional services, office consumables and so on.
- Pull everything together
Add in the money from your sales forecast, non-sales income and money out from your profit and loss forecast plus VAT payments, if applicable, and corporation tax and any other costs based on your list of assumptions. Pulling this all together into a cashflow forecast – a projection of how cash will flow into and out of your business will give you a great tool to assist you in business planning and obtaining the funding you need.
Avoiding cash flow nightmares
Cash flow forecasting can involve working with limited information so accuracy can be a problem. Keep your assumptions conservative.
Getting your cash flow forecasting right can help you avoid common problems. In addition to forecasting there are a few other ways to avoid cash flow nightmares.