Financial projections and forecasts are not just for the multinational corporations of the world. They are extremely valuable assets when executed correctly especially for start-up businesses where a healthy cash flow is a basis for its future growth. A cash flow forecast is one such financial plan which can help you to make important decisions about the future of your start-up business. Read on for an in-depth guide to creating a cash flow forecast and why it is so important for the growth and development of your business.
What is a cash flow forecast?
An important aspect of your business is understanding your cash flow. A cash flow forecast takes how much you expect your business to earn in sales, how much your day to day running costs are and how much you will receive from other sources such as a bank loan and other costs such as buying new equipment. This allows you to see how much your business will receive and pay out over a certain period of time.
Cash flow forecast advantages
Taking all your future payments and transactions into consideration and creating a cash flow forecast for where your business will realistically be in 3 to 5 years’ time. It will also tell you how much money you need to get your business there and when you can expect to receive payments from your clients.
Knowing when your business may have a surplus or be short on funds can help you plan for the weeks, months and years ahead. You’ll be able to see for example that it’s best to wait another year before hiring a new employee or when is the best time to start reinvesting in your business.
Another benefit of a cash flow forecast is that you can start to plan the effect of what certain business decisions will have on your cash flow. From hiring an extra employee and moving office locations to a 15% decrease in sales, you can play out certain situations and make contingency plans for your business.
Having the budget for the coming months and years stacked up against the spends and income will allow you to see in real-time whether your business is on track to meet your future predictions. It will also provide you with the first warning sign if you are overspending or if your business is running inefficiently, allowing you to adjust to put your business’ finances back on track.
For your business to reach the goals you have in mind, cash will be one of if not the most important resource. Having a cash flow forecast sets out your vision, the potential for the business as well as the finances you need to reach those goals. Having an accurate and updated cash flow forecast means you can approach the bank for a loan or share the information with your stakeholders for a new round of investment or advisors to get informed guidance for your business.
Disadvantages of cash flow forecast
Your business cash flow can be affected by external factors which you won’t be able to plan for within your cash flow forecast. Whether it’s a new competitor with a bigger bank balance, government regulations or the introduction of technology, you will have to adjust your expectations and forecast based on the unknown.
It’s also important to consider that your cash flow forecast is made from rough estimates which can give you an inaccurate view of the future of your business. Based on your current and possible future cash flows, you’ll be using this forecast as a means to take important business decisions. When doing so, it’s important to consider the inaccuracy of this forecasting tool.
You will need to continuously adjust your cash flow forecast as the business environment is extremely volatile, especially for start-ups and small businesses. Involving a certain degree of estimation and probability, no forecast is in the short or long term 100% accurate. The further you extend the forecast the higher the probability is that your forecast will be inaccurate.
How to do a cash flow forecast
Creating your first cash flow forecast may seem like a daunting prospect but the whole process can be broken down into the following three steps which will have you admiring your cash flow forecast in no time at all:
Step 1 – Sales forecast
Your sales forecast which you should break down month by month is a plan of how much you expect to sell in the future. Open up an Excel spreadsheet with a column for each month of the year and a row for each product or service that you sell. Don’t include any sales tax such as VAT in your forecast. To help you forecast your future sales analyse your previous year’s sales figures or look for seasonal trends in your industry. Don’t forget to include a ‘total’ row and column in the spreadsheet. The total row is extremely important as this will feed information to your profit and loss forecast in step 2.
Step 2 – Profit and loss forecast
You’ve got your forecasted sales, so it’s time now to forecast your day to day running costs and possible future business costs before combining it with your forecasted sales, creating a profit and loss forecast. With a column for each month, the first row of total sales should already be populated with the information from your total monthly sales forecast (step 1). Beneath your sales figures make a row for all your business running costs such as sales costs, administrative expenses, overheads, employee salaries, UK employer’s National Insurance contributions, manufacturing or software packages. Include the costs in the month that you incur them rather than the month you pay for them and as in your sales forecast, your costs should be exclusive of sales tax. Do not include one-off costs such as buying replacement equipment in your profit and loss forecast, you’ll be able to include these in your cash flow forecast in step 3.
Step 3 – Cash flow forecast
Now that you’ve calculated your sales forecast and profit and loss forecast, you can now start to map out your cash flow forecast. Create a column for each month and a row for each type of flow of cash that’s coming in or being paid out.
Cash flow – money in
We recommend starting first with the amount of cash you’re expecting to come in. Do not copy your sales forecast figures as your cash flow forecast should list the income when it is paid in and not when it is invoiced. Take into consideration the time it normally takes for your customers to pay: is it instant, do they pay you up front or do you have a particular customer that never pays on time? Unlike your sales forecast and profit and loss forecast, your sales income should include the sales tax. You can then list on each subsequent row any income other than sales that you may have, for example, a bank loan. Add in a ‘total money in’ row to your cash flow forecast template in excel.
Cash flow – money out
Take the costs from your profit and loss forecast (step 2) and put them into the respective column depending on the month you plan to pay that particular cost. For any costs added in, make sure that they are inclusive of VAT. After calculating your day to day running costs from the profit and loss forecast you need to add a row for each additional cost your business will incur such as buying new equipment or having to pay a certain tax. Include a ‘total money out’ row in your spreadsheet.
Subtract your total monthly cash flow out from your total monthly cash flow in to see how much money will be coming in or going out each month. You can all this row you ‘net cash inflow/outflow’. Take each month’s net cash inflow/outflow and add it to your bank balance as at the end of the previous month to see how much cash you can expect to have in your account at the end of the current month. This will let you see where you may need an extra injection of cash or where you will have a surplus.
Cash flow forecasting techniques
There are two types of cash flow forecasting methods – direct or indirect. Direct cash flow forecasting can be used for short-term liquidity management purposes and forecasts for a period of more than 90 days. The direct cash flow forecast does not include system-based cash flows and is, therefore, closer to real-time figures.
On the other hand, indirect cash flow forecasting can be used for longer-term liquidity management purposes. This technique relies heavily on a number of indirect methods of building up a cash forecast such as projected balance sheets and income statements.
How can a business improve its cash flow?
Having set up your cash flow forecast you can analyse it to see where you can improve your business’s cash flow.
If your business is affected by seasonality you can improve your cash flow by analysing whether or not to diversify your product or services during these months.
A quick way to improve the cash flow of your business is to stay on top and chase up any debts your clients may owe your business. The longer you leave a debt uncollected, the harder it becomes to receive a payment. You can, therefore, introduce a debt chasing process for your business to stay on top of any unpaid bills.
Making early payment plans available to your customers is a great way to increase your cash flow as you’ll be receiving your payments earlier and you may be able to attract more customers who are incentivised by early payment discounts.
Improve your business cash flow by cutting costs and only making business critical purchases. You will need to review every aspect of your business to see where you can cut costs. For example, instead of having an office with twice the amount of space you actually need, you can consider moving into a co-working space to save on your running costs and bills.
Ensuring the future of your business
Failing to map out a cash flow forecast can have detrimental effects on your business, especially if it is a start-up which is more vulnerable to a sudden fall in cash flow. If you need some further help with your cash flow forecast, there are plenty of free cash flow forecast examples and templates available online.
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