Most small business owners want their accounting done so they can focus on doing what they love. But tracking and forecasting cash flow – despite the time and effort required – is essential for starting, operating, and expanding a business successfully.
In this guide, we’ll discuss the purpose of a cash flow forecast, the benefits it can have on your business, and give you tips on getting started with cash flow forecasting.
What is cash flow forecasting?
Cash flow forecasting involves estimating your future sales and expenses. A cash flow forecast (also known as a cash flow projection) is a vital tool for your business because it will tell you if you’ll have enough cash to run the business or expand it. It will also show you when more cash is going out of the business than in. These forecasts are flexible in the periods they can cover, such as a year, a week, or a month.
With a cash flow forecast, you ignore sales on credit, accounts payable, and accrued expenses, and instead focus on the revenue you expect to collect and the expenses you expect to pay during a given period. If available, information provided on past cash flow statements will be a useful tool to help estimate your expenses for the period you’re forecasting for.
What are forecasts used for?
Cash flow forecasts are primarily used to help business owners plan how much cash they’ll need in the future. It is not uncommon for a business to experience a cash shortage, even when sales are good. This usually happens when customers are allowed to pay after the product or service is delivered. In cases like these, a business owner must plan how they will cover costs before receiving the payment.
Understanding cash flow is one of the keys to running a successful business, particularly for small businesses and new businesses that don’t have established income streams and more expenses than they have revenue.
Why forecast cash flow?
To predict cash surpluses and cash shortages
By identifying potential future cash flow gaps, businesses can take measures to prepare for these. For example reducing cash outflows for that month, using credit to pay suppliers, or saving surplus cash for these periods. This is a particularly important benefit of cash flow forecasts for businesses who experience significant seasonal sales fluctuations.
Effective cash surplus management
Just as cash flow projections can be used to identify periods of negative cash flow, it can also be used to predict periods of positive cash flow. Being aware of when you will have surplus cash available - you can use this positive cash flow balance to your advantage. A prolonged period of positive cash flow could mean that you have enough surplus cash to invest in new equipment or processes that could benefit your business in the long run.
Monitor late paying clients
Cash flow forecasting can also give you insight into clients who regularly pay late and impact your cash flow. By identifying these clients, you could create more strict credit periods to improve your cash flow and avoid periods of negative cash flow due to these late payments.
Run hypothetical business scenarios
Scaling and growing your business always comes with a degree of risk. Using cash flow forecasts, you can play out the financial implications of hypothetical business scenarios. For instance, investing in new production equipment, offering next day delivery offers, or understanding the cash flow implications of launching a seasonal product range.
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 input the proposed employee’s salary and other related costs into your cash flow forecast.
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.
When should a business start a cash flow forecast?
Financial projections are essential for any business, even if it’s not yet generating revenue. So, if your plan is to build an economically viable business, to be better prepared for the future, communicate your company’s performance to potential shareholders or new investors, or set targets for your company; then you should prepare cash flow forecasts.
While you may feel you need historical data to prepare cash flow forecasts, that is not strictly the case. It is never too early to prepare cash flow forecasts. If you’re just starting out, using online accounting software will help you to stay in control of your data. By doing so, you will gain a better understanding of your business, enabling you to make better decisions during the vital early stages of your company.
Decide how far out you want to plan for
Forecast your income/sales
Estimate cash inflows
Estimate cash outflows and expenses
1) Decide how far out you want to plan for
Cash flow planning can cover anything from a few weeks to many months. Plan as far ahead as you can accurately predict. If you’re well-established, you might have a predictable sales pipeline and data from previous years. If you’re a new business, you might not have a huge amount of information – so the further out you go, the less accurate your predictions will be.
2) Forecast your income/sales
To forecast your sales, look at last year’s figures to see if you can spot any trends. You can make adjustments to your sales forecast based on whether sales increased, decreased or stayed the same.
When estimating these 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
If you’re a new business and don’t have past sales figures, start by estimating all the cash outflows. This will give you an idea of how much money the business needs to bring in to cover it.
3) Estimate cash inflows
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.
Next, you’ll estimate your other ‘cash inflows’, or sources of cash other than sales. These will vary from business to business but might include:
- a loan being paid back to you
- selling an asset
- VAT rebates and tax refunds
- startup business grants or startup government support
- owners investing more money (adding extra equity) in the business
- other sources such as royalties, franchise fees, or licence fees
4) Estimate cash outflows and expenses
Now it’s time to calculate your costs. These include both fixed and variable costs. 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 corporation tax payments or lump insurance payments.
When you calculate your cash outflows, work out what it costs to make goods available. This way, if you need to adjust your sales numbers later (for example, if you actually sold 10 units in March when you thought you would sell 5), it will be easier to adjust the actual cost of goods sold.
Tax-deductible expenses for companies or sole traders can be money spent on administration or operation. These will also depend on the type of business but might include:
- Raw materials
- Bank loans, fees, and charges
- Marketing spend
- Tax bills
Sources of information to help a business forecast cash flow
There is no substitute for experience of running a small business. Some of the assumptions will be based on “gut feel” and instinct. A cash flow forecast produced by an inexperienced entrepreneur must rely much more heavily on other sources.
Startups can get help from advisers when putting the cash flow forecast together. The advisers might be from Enterprise Ireland or another government-funded agency. It could also be your local bank manager or accountant – whose help is particularly useful when it comes to making sure the forecasts are complete & mathematically sound.
A great source of information on costs and the timing of payments. What are the industry norms for paying suppliers in the market?
Market research into key aspects of sales and costs
For example, seasonal fluctuations in demand, average selling prices and quantities in the market, typical gross profit margins, the lead-time between marketing campaigns and orders etc.
Who prepares a cash flow forecast?
01. More efficient forecasting
Accountants will offer a second pair of eyes to help identify where cash is being wasted and to identify what positive changes you could make to release some cash flow and make the business more cash positive.
02. Expert support and guidance
When a business is struggling with its finances, it’s very easy to feel overwhelmed and then it gets difficult to find a way out. Bringing in a professional accountant with a new perspective may be all you need to make those key strategic decisions and to turn your cash flow problems around.
03. Peace of mind forecasts are accurate
Cash flow forecasting is based entirely on projected estimates and probabilities, and because of this, plans become less accurate the further into the future they extend. To increase the accuracy of forecasts, it is best practice to have an accountant compare projections to actual bank statements for the same period and adjust future forecasts accordingly to create a more accurate picture.
04. Reliable information
Support from an accountant can ensure that you’re integrating accurate tax payments into your planning so they don’t have a sudden negative impact on cash flow. They will also enable you to change old, negative habits and get your books back onto the straight and narrow, so that you can see where the cash is coming and going.
Want our support?
Cash flow forecasts are essential for businesses that want to start, grow, and scale successfully. They help business owners/managers to project their future sales and expenses and help you to plan your finances so you can make better decisions for the future.
Our team of professional and qualified accountants understand the importance of accurate cash flow management and forecasting. They provide cash flow forecasts in a simple, reliable, and cost-effective way.
For more information on how we can help your business to predict, monitor, and report on cash flow – get in touch with you now. We’re always happy to help.
Tom is a Fellow Chartered Certified Accountant (FCCA) and Chartered Tax Advisor (CTA) and is Accounting Team Manager at Accountant Online. Areas of expertise include Accounting, Compliance, Taxation relating to small business and company directors.