Cash Flow Forecasts: How and When to Use Them

If your business runs out of cash and can’t obtain new finance, it will fail. That’s why it’s critically important that you monitor and manage your cash flow. 

Cash flow forecasts are one of the most important tools you can use to make sure your weekly, monthly and yearly financials remain healthy and solvent. In this blog post, we’ll take a close look at cash flow forecasts, the ins and outs of creating them and why they’re so important for businesses of all kinds.

 

What is a Cash Flow Forecast?

Cash flow forecasts estimate the amount of money you expect to receive into the business and expend during a certain period of time. These forecasts are flexible in the periods they can cover, such as a year, a week, or a month.

Understanding cash flow is one of the keys to running a successful business, in particular for small businesses and new businesses that don’t have established income streams and more expenses than they have revenue. A healthy, predictable cash flow will increase your company’s stability and help you to manage the natural ebbs and flows of your financial landscape.

 

How to Create a Cash Flow Forecast

Cash flow forecasts are fairly straightforward to prepare, and it’s likely that you already have the information you’ll need for your forecast. 

The first step is to estimate your likely sales. Using your previous sales history for a set period of time, generally 12 months, and create a cash flow forecast for the coming year, month or week based on past sales trends. Most industries have predictable ebbs and flows based on seasonal demand. If you find abnormalities in your sales history (e.g. you went to a trade show and had an unusually high number of sales one particular week), ensure these are factored in to the periods they relate, this is also true for any grants, incentives or rebates you could be expecting or have applied for and the applicable months they are due to be received. 

Cashflow is particularly hard to start ups businesses, where the flow of funds is mostly one way, out. So when you have little or no sales to populate your cashflow forecast with you can consult the sales performance of similar businesses as well as figures from suppliers and industry experts. 

As you estimate your likely future sales, keep the following factors in mind:

• Current market conditions for your industry
• Current trends
• Future business plans (new marketing campaign, promotions, etc.)
• New product lines or new services
• Entry of new competitors to your market 

The next step in the creation of a cash flow forecast is to estimate your payment timing. When do you expect to receive payment for your sales? Again, you can base this figure on past payments if you have historical data. If you offer 30 days for payment, for example, you should build a 1-to 2-month buffer into your payment forecasts.

Finally, it’s time to calculate your costs. These include both fixed and variable costs, so again, you’ll need the help of historical data. Fixed costs are the costs you have to pay regardless of how much you sell in a given period. Variable costs change according to your sales. For instance, you’ll have more shipping costs in months when you have more sales. Look through your historical data carefully for items that you only have to pay once or twice a year, such as tax accounting services or lump insurance payments.

After you have all of this information compiled, all you have to do is to add your opening bank account balance and add your revenue less your expenses for any given week or month. It’s important to update your cash flow forecasts on a regular basis using your actual business performance.

 

Why Prepare Cash Flow Forecasts?

Successful business leaders use cash flow forecasts in several important ways. Let’s look at a few:

To Predict Surpluses and Shortages

Use your cash flow forecasts to predict surpluses and shortages in your company’s finances. If a large tax bill unexpectedly hits your cash flow, you could have a difficult time maintaining inventory or paying suppliers. Conversely, if you have a large surplus of cash, your taxes may be affected in ways that are difficult to predict. 

Avoid uncertainty by using a cash flow forecast to predict your surpluses and shortages. With this information at the ready, you’ll be in a better position to make wise decisions at any given point in time.

To Make Critical Hiring Decisions

Without a reliable cash flow forecast, it can be difficult to make good hiring decisions. For example, you may feel that you need another employee to help you keep up with the workload. To gauge whether or not this is a wise financial decision, you can plug the proposed employee’s salary and other related costs into your cash flow forecast.

To Create Best- and Worst-Case Scenarios

When you’re facing a risky decision, it can help to know your best- and worst-case scenarios. Cash flow forecasts can help you to know just exactly how risky certain decisions could be by illustrating what could happen to your daily, weekly, and monthly cash flow under ‘what-if’ conditions.

To Spot Problems with Customer Payments

If your cash flow forecasts aren’t lining up with your actual business performance, you might have a problem with customer payments. Use your cash flow forecasts to pinpoint these issues so you can resolve them before they drag your finances down.

To Show to Your Stakeholders

If you want to acquire a loan for company expansion or the purchase of property or equipment, you’re going to need accurate financial reports such as cash flow forecasts that show you can service the debt and provide piece of mind for your financiers.

To Serve as an “Early Warning System”

Too often, cash flow shortfalls take businesses by surprise, causing expensive and time-consuming last-minute fixes such as short-term loans or the delay of important purchases. Don’t let this happen to you. Use your cash flow forecasts to anticipate large expenses and to use budgetary surpluses to your advantage.

For more information about creating and using cash flow forecasts, or to speak with one of our business experts on any topic of concern, get in touch with us at Altus Financial.