Cash flow forecasting
What is a cash flow forecast?
‘Cash flow’ is a term for the money moving in and out of your business every month.
A cash flow forecast is a plan to show how much money you expect to receive, and how much you expect to pay out, over a certain length of time in the future.
Why do cash flow forecasting?
Having an awareness of your cash flow position and reviewing your future cash flow position will allow you to make informed decisions in your business and carry out scenario planning, particularly pertinent in more challenging trading periods.
A cash flow forecast is also required if you are looking for external funding from banks or investors.
Creating a cash flow forecast - a step by step guide
Step 1: Understanding your business
If you are looking to make important decisions in your business, whether it is take important decisions, spot risks or issues, understanding your cash flow position is key.
The first step to create a cash flow forecast is to understand how your business is performing in real time. Your accounting records should be kept up to date for you to more accurately predict your future cash flow, which in turn will allow you to make swift decisions to achieve your business goals.
Using cloud accounting software allows for real time accounting and view of your business numbers. Most of these cloud accounting packages offer reporting tools, even to very small businesses, to help you project and plan your future cash flow. And the reporting allows for very simple reporting to more complex data analysis, again, only possible if the accounting processes are accurate and up-to-date.
Once set-up correctly on the accounting side of your business, you will be able to analyse your cash flow position and review your costs.
Step 2: Review your costs
Cost control is vital to all sized businesses and at every stage of a business cycle. As we have seen during the pandemic, even the largest businesses have fallen due to the lack of working capital.
When reviewing costs, you should look at fixed versus contractual costs, which costs can be reduced or deferred and whether there is any discretionary spend.
Will your short to medium plans mean that your costs will need to change to reflect these costs?
Costs are central to cash flow forecasting and you should analyse between fixed, contractual, variable, and discretionary costs. By actively distinguishing between these costs in the first instance will help you better cost control in the future.
By reviewing costs line by line and logging when payments are due, you will have a much better understanding of the timing of your regular and non regular payments and therefore building the foundations of your cash flow forecasting.
From here, you can prioritise your costs, identifying what can realistically be saved or reduced. Make sure you prioritise key suppliers and relationships. Scale your costs, whether up or down, to what you expect your business to look like going forwards.
Other than expenses, there are other costs to consider such as loan repayments, tax payments, finance payments and other creditors and personal drawings as a business owner.
Step 3: Look at future income
Even in normal times, projecting cash flow based on previous income levels is useful but uncertain as you plan for the future. In these challenging times, it will be even harder to look beyond one to three months. Of course, you could be a business that is fortunate enough to have certainty on sales.
Either way, it is a good exercise in this next step to review what income is predictable and what income is more uncertain planning ahead. For example, do you have long-term contracts or regular, repeatable income from customers? Is there any seasonality to your income levels?
At this point in the cash flow forecasting process, you are now at the point where you can bring forward your aspirations for the business, whilst of course also being realistic. When considering your future business plans, look at where you will need to review your costs, in particular paying particular attention to variable costs that fluctuate with sales.
Also at this point, you should consider your future pricing point and what customers or clients are willing to pay for your product or service. One of the biggest cash flow issues all businesses face is not being paid on time. This is a factor you may therefore need to factor into your cash flow forecasting plans.
If you use direct debits for sales in your business, this does better help you plan your cash flow more accurately, as well as being able to see which payments have failed and why, allowing you to act quickly with a client before financial issues get out of control.
Step 4: ready to Forecast your cash flow
Now that you have carried out the steps above on cost and income analysis, you are ready to develop your cash flow forecast.
The key to developing a meaningful cash flow forecast is to:
Understand what you are going to use the forecast for - is it or internal planning or to get a loan from the bank, for example?
Choose a cash flow model, making sure it is simple and easy to update
Keep reviewing the forecast and amending if required
Review your businesses cash needs
If you identify cash issues that need to be addressed, make sure you act as early as possible
Do you use a cash flow forecasting software, such as Float or Fluidly? If so, which one do you use and why? Please get in touch and let us know how you carry out your cash forecasting in your business.
