Cash flow is an integral part of running any business. It enables you to cover your financial commitments, keep operations moving smoothly and prevent any obstacles that might cause disruption. It’s also crucial in fuelling growth and avoiding debt.
You need to maintain positive cash flow to experience the benefits. One part of doing this is understanding the money coming in and out of your business and maintaining appropriate balances. Cash flow forecasting helps you to do exactly that.
Alongside being a critical part of your business planning, cash flow forecasts will commonly be required when applying for external funding to determine the ability of your business to repay any loans.
We explain how to create a cash flow forecast in our step-by-step guide.
The steps to creating a cash flow forecast
Choosing your reporting period
A cash flow forecast will typically cover 12 months, but it is also used for shorter periods – even as little as a few weeks. It’s essential to define the timeframe you will cover in advance, as this will enable you to predict your income and expenses accordingly.
Shorter-term forecasts have a role, especially if they align with other plans or projects. For example, if you are pursuing a growth strategy that takes three months, you might compile a three-month forecast alongside it to review the cash flow impact. This can uncover how sustainable your plans are.
Start by considering what you want that suits your particular circumstances, such as an immediate cash flow.
Start with income and sales
To start your forecast, plan out your sales for the required period including your estimated sales figures, contract payments or renewals, or even new product lines that might bring in extra sales.
If you have them, it’s wise to use past sales figures to predict your future income, as this will give you reliable data to work with.
However, it’s also essential to remember that many factors affect sales, including changing market needs, the threat of competitors and other contextual issues. If you are aware of these already, consider the impact on your sales and adjust your forecasts accordingly.
If you don’t have past sales figures to rely on, conduct research to determine what similar businesses sell or other data and use these as a baseline.
Estimate other income
Next, you need to estimate any other incoming cash outside your sales. This may include the sale of assets, repayment of monies owed to you, grant funding, tax refunds, increased investment from shareholders and so on.
It’s vital to calculate this income alongside your sales income. It will give you a comprehensive view of the total monies coming into your business during the reporting period for improved accuracy of your cash flow situation.
Estimate cost of sales and overheads
Once you have calculated your income, it’s time to focus on the money going out of your business. Typically, this will include costs of sales and overheads (such as supply costs, service fees, staff salaries, rent, marketing spend, tax and other bills) and other outgoing payments, such as loan repayments, shareholder entitlements or money put into reserves.
When you’ve listed all your business expenditure during that timeframe, add them together for your total outgoing amount.
Bring it all together
The next step is to subtract your outgoings from your income, which will indicate the estimated surplus or deficit that you have at any set period.
If you’re doing a long-term forecast (such as 12 months), you will normally break this down into months so you see how your cash flow will fluctuate over time. This will highlight any months where money is tight, so you can proactively build up your reserves to mitigate any risk.
Now you have identified months where there are cash deficits, it is worth reviewing your plans and to see if you can lower any costs or raise income. The alternative is to ensure you have strong enough reserves to see you through (for example, if you are undergoing a growth period where costs temporarily increase).
Review accuracy as you go
While a forecast is a valuable tool in your financial planning, it is ultimately just an informed prediction. Only when the months unfold will you know your true cash flow position.
That’s why it is essential to review the accuracy of your forecast as you go.
As each week or month of the reporting period passes, reflect how your forecast compares to the actual cash flow. Identify any differences, it will help you uncover issues with your planning and help you learn how to be improve your accuracy for the future.
It’s worth mentioning that unexpected factors will arise that will impact your forecasts. By constantly reviewing your actual results, you will know when your cash flow trajectory has changed and address any issues accordingly.
The more often you review your finances, the better your future forecasts will become.
In summary
Maintaining surplus cash flow is key to the ongoing running and success of a business. By accurately forecasting your cashflow, you will ensure you manage it effectively and avoid the common barriers that lead to more significant issues.
It also enables you to chart the financial performance of your business in the month and years to come and drive agility. This, in turn, improves your business planning, including implementing growth strategies.
There are a number of external funding solutions, such as trade, stock or invoice finance, to help alleviate the pressure of any cashflow issues you have.