How to do a Cash Flow Forecast

"Profit is an opinion, cash flow is a fact."

Would it be useful for you to have some idea of how much cash you had available a few months out?

Don’t stumble into a cash flow nightmare.  Properly managing your cash can be the difference between success and failure.  That was the message from my last blog.

As Dun & Bradstreet put it, “Prior warning of any liquidity problems allows businesses to find solutions to any temporary cash shortfalls, or to arrange short-term investments for temporary cash surpluses.”

Your accrual based accounts may well be telling you that your business is profitable, but your bank balance may be warning you that it is not that easy. 

Your bank balance is a “lag indicator”; it reflects the outcome of decisions made in the past and the trading conditions you were facing.  What you need is a “lead indicator”, something telling you what is likely to happen.  That is just what a cash flow forecast does.

The last blog discussed why you should do cash flow forecasts.  How do you do a cash flow forecast” is the obvious question, whether it be for operational, investment or financing activities.

Good cash flow management requires you to know exactly how much money is going in and out of your business, and is likely to be flowing in the period ahead.  It will guide every decision you make.  Keeping a close watch on cash is one of the fundamentals of business survival.

What is a cash flow forecast?

Cash flow forecasting is the modelling of a business’s future financial liquidity over a specific timeframe.

A cash flow forecast indicates the likely future movement of cash in and out of your business.  It's an estimate of the amount of money you expect to flow in (receipts) and out (payments) of your business and includes all your projected income and expenses.  A forecast usually covers the next 12 months; however, it can also cover a short-term period such as a week or month.

How do you do it

The simplest method is to create a cash flow template in a spreadsheet that shows cash coming in from all sources for the period under review, and all cash going out for the same period.   You should prepare a 12 month projection, with the first 3 months in more detail. 

Step 1:  List your assumptions – this is a forecast, so you will be making assumptions and these will be specific for your industry and business.  You base them on both your experience and business plan for the year ahead.  For example:

•    What is your seasonal pattern of sales

•    Are there any economic or market place factors likely to impact on your business over the next 12 months that have to be factored in

•    Have you planned any price increases for the period under review?  If so, by how much and when?

•    What proportion of sales will be cash, credit card or invoiced.

•    Of those invoiced, what proportion will be paid 30 days, 60 days, 90 days

•    Are your suppliers likely to increase prices?  If so, by how much and when?

•    Are there likely to be wage and salary increases?  If so, by how much and when?

•    Do you have any investments planned, such as buildings, plant or equipment?  When? How will you finance these?

Listing the assumptions within the forecast adds credibility and serves as a reminder when assessing actual performance against forecast.  It also makes it easier to adjust your forecast as you review.

Step 2: Project sales month by month

Sales can be difficult to predict.  I find the best place to start is looking at the patterns over the previous 2-3 years.  Very often there is a similar pattern.  Then of course, you need to consider whether any market place factors are likely to disrupt that pattern. 

Now bring in your assumptions of price increases and make any necessary adjustments.

Having determined the sales line you must now factor in your assumptions about cash, credit card and invoice payments.  Enter the expected cash and card sales immediately, and the invoiced sales when your customers are likely to pay you. Your credit sales income will depend on your credit management policy.

Finally, you need to bring in any additional cash receipts such as interest earnings, dividends, grants, refunds, or asset sales

Step 3: Project Expenses month by month – Remember you are not calculating Gross Profits so you don’t need to have any distinction between variable and fixed expenses.  Include both.

The key is identifying all the expenses required to operate the business and anticipating the timing of each payment.  Again looking at the patterns over the last 2-3 years is a useful tool.

You need to include all suppliers (and when you pay them), all administrative costs, marketing and promotional costs, employment costs, motor vehicle costs, occupancy costs, interest payments, lease or hire purchase and so on.

Don’t forget to include loan repayments, taxes and Directors drawings if you have these, and any Direct Debits.  The latter can be easily identified from your bank statements.

Step 4:  Bringing it all together

A cash flow forecast is a rolling calculation based on an opening cash position, adding cash inflows and deducting cash outflows, to arrive at a closing cash position.  So you need to start with your opening bank balance, which is the closing bank balance for the previous period; for example, the end of the financial year.

You will now be able to see which are the tight months (you can also do this weekly for the immediate period ahead), when you might need overdraft facilities, when you might need to take steps such as a special promotional program and so on.

The other great benefit from having this modelled is that you can run “what if” scenarios to test how resilient you are, or the impact of investment decisions.

How often do you review

My immediate answer is – regularly.  Certainly never less than monthly, as part of your management report.  But if things are tight for you, you should be forecasting and revising your cash flow on a weekly or even daily basis, depending on the nature of your business.  

The point of making the forecast of incoming cash is to manage the outflow of cash so that the business remains solvent.  To quote a friend (John Williamson) “Cash flows do tend to solve the problems with unhappy bank managers.”

Should this seem a little complicated you can find a number of free templates on the Internet.  I liked this one from the Victorian Government

If you do have cash flow problems and need some assistance in working your way out of them, I can help.  That is just what the Profit Leak Detective does.

To your cash flow heaven.

© Copyright 2014 Adam Gordon, The Profits Leak Detective

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