What you need to know about a cash flow forecast
Cash flow is the lifeblood of a business. When revenues are stable and plentiful, businesses can focus on growth and prosperity. When cash flow is weak, however, businesses may struggle to meet their costs and pay their staff.
Fortunately, there is a process that businesses can put in place which may help them take control of their cash flow; cash flow forecasting. It involves managing, monitoring, and projecting your cash flow to protect your business’ financial health. In this guide, we’ll touch on:
- What is a cash flow forecast?
- What metrics to include a cash flow forecast
- The advantages and disadvantages of a cash flow forecast
- How to make a cash flow forecast
- What happens when you don't forecast?
What is a cash flow forecast?
A cash flow forecast is a document containing a projection of a business’ finances over a specified period. For some smaller businesses, this could be as simple as using one Microsoft Excel spreadsheet, while others may opt to pay for third-party accountancy software to bypass some of the number-crunching work and automate the forecasting process as much as possible.
Exactly how far in advance SMEs should look to forecast differs based on their business goals. If a business’ monthly cash flow is volatile, then a more short-term forecasting model may be a better option – which has been the case for many businesses during the global pandemic. However, more established businesses that are used to having a steady month-on-month cash flow may opt for a quarterly projection model rather than taking a more granular daily or weekly view.
What metrics to include in a cash flow forecast
Regardless of the scale of the forecast, which will vary depending on revenue volumes, there are some fundamental concepts that all forecasts should follow. These include:
Every forecast should track money coming into a business. Mapping the sources of incoming cash, i.e. channels or clients are generating revenue for the business, should help to make a better-informed decision about how to grow a business. Other examples include any capital being injected into the business from investors, sales, or any external finance you may be using - such as a business loan, or even invoice finance.
Naturally, forecasts also include business’ expenditures. That’ll include the employees’ wages, any interest on external financing agreements, or the cost of any third-party platforms or software being used, for example, if a business is outsourcing its digital marketing to an agency. Having all cash inflows and outflows documented will help to determine the net cash flow of a business.
Net cash flow
This is perhaps the most useful output of a cash flow forecast. By deducting the cash outflow from the cash inflow, there’ll be an overview on whether a business is likely to be profitable. While historical data is used to help strengthen a forecast to get an idea of year-on-year cash flow movements, it is important to remember forecasting is an estimation based on calculated projections and speculations.
Opening and closing balance
Further metrics that are often incorporated into a forecast include the opening balance, a business’ bank balance at the beginning of the month, and the closing balance, a business’ bank balance at the end of the month.
The advantages and disadvantages of a cash flow forecast
Starting a forecast using this simple structure could help an SME to start taking control of its finances. Consequently, a business could develop the sort of insights to influence top-level business strategy. Let’s take a look at how:
Benefits of a cash flow forecast
Some of the advantages associated with cash flow forecasting include:
- Identify vulnerabilities using financial projections: Spotting points at which a business is likely to struggle to find cash, helping to inform management on whether to inject more cash into a business or pull back on certain types of spending.
- Plan to save and invest: for businesses that enjoy a positive net cash flow at the end of each month, forecasting could help get an idea of exactly how much money is available to save or even to reinvest and expand the business.
- Improve your chances of securing external finance: lenders may require seeing (or simply appreciate) a forecast to ensure that a business plan is viable – helping establish the business as a desirable lending prospect.
Limitations of cash flow forecast
It’s also worth noting that cash flow forecasting isn’t an exact science, and there can be some drawbacks:
- Creating detailed forecasts could prove time-consuming for small teams.
- Forecasts are largely speculative and rarely completely accurate. The further into the future the projections are, the less likely the forecasts will be accurate because of an increasing chance unpredictable market changes or legislative changes, which are especially true during the coronavirus era. If you aren’t put off by these potential challenges, then it’s time for you to start thinking about how to implement or upgrade the forecasting processes within your business.
How to make a cash flow forecast
When starting from scratch with a low budget, you may want to start by creating a ‘cash flow forecast’ Excel document.
Remember to include the fields we’ve outlined above:
- Cash inflows
- Cash outflows
- Net cash flow
- Opening balance
- Closing balance
Then input as much historical data as you feel could be useful, before having a conversation with your team about how you can look to forecast into the future. You’ll likely want to consider how your cash flow could change if you’re:
- Releasing a new product range
- Increasing working capital to purchase more stock and capitalise on increased demand
- Anticipating competitor activity
- Undertaking activity that could directly or indirectly affect revenues e.g. increased investment in digital advertising
- Planning for the future and looking to expand
- Factoring in new staff hires
Having this conversation should help you determine how stable your cash flow is likely to be, and from that point you can choose whether you’re forecasting for the upcoming days, weeks, months or even quarters.
If you’re serious about forecasting and need to work with a lot of data, then you may want to consider taking advantage of an accountancy or cash flow forecasting apps, such as Xero, Free Agent, Quickbooks, Sage 50, Netsuite and Kashlow. These applications can plug into your business bank account to extract your cash flow data directly from source, and they often offer intuitive interfaces that can help break your financial data down into digestible insights.
What happens if you don’t forecast?
Of course, there have been businesses that have had success without forecasting – but unless a business has experiencing explosive growth, this is usually not a good idea. Cash flow forecasting is particularly useful because it can help to distinguish between a business’ profits and revenues.
If a business experiences huge profits each month then it’s easy to assume the business is in a ‘safe’ place, however, through forecasting a business could identify that its cash inflow has shifted to become dependent upon certain clients or product lines. Forecasts would allow businesses to proactively plan for fluctuating revenues from these important clients or product lines. That’s exactly what cash flow forecasting is about; empowering a business owner to be proactive with financial decision making, and to use all available financial data effectively.
If you’re interested in reading more about this topic, check out our article on whether cash flow forecasting is an essential for SMEs, or read some expert advice on where businesses typically go wrong with forecasting.
What could Rapid Cash do for you?
To be eligible for Rapid Cash you must be trading for at least 6 months, have an annual turnover of at least £100k and either be a Limited Company or Limited Liability Partnership registered in England and Wales. Additionally, you need to invoice other businesses and use one of the following digital accounting software: Xero, Quickbooks, Sage 50, Kashflow, FreeAgent and Netsuite.
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