At some point, every small business suffers cash flow problems. The trick is to think ahead and figure out when these problems might arise, so you don’t have to postpone a purchase or hurriedly seek out additional finance. This is where cash flow forecasts come in.

Effectively managing your cash flow is essentially a case of using your sales and expenses figures to calculate your cash flow figures before they happen. You can then plan to limit the impact of a cash drought before it arrives so you can still pay your staff, the bank and your suppliers.

The importance of cash flow forecasts

Cash flow forecasts predict your business’s financial position for the period ahead, from three months to a year. Your projections allow you to see what money you expect to pay into the business and the amount you’ll need to payout. It’s a useful tool to help you manage your business more effectively.

If you owned a typical retail store with high sales over Christmas, and then a traditional slump after the New Year Sales, your cash flow forecasts would show high income in December and much lower income over the following two months. Your forecasts would also show stock purchased on a 60-day term ahead of the festive Christmas rush in November and December would need to be paid at the end of January and February.

If you racked up record Christmas sales, there might be a strong temptation to splash out on that big-ticket item you’ve been craving – but can you really afford it? A quick look at your cash flow forecast will probably tell you that you need to park the thought of a new SUV or fishing boat and reduce your drawings by downgrading your request to Santa for an iPad. Otherwise, you’ll have no money left to pay for the stock you sold in December.

If you’re more pragmatic and less inclined to impulse spending, your forecast will also be able to tell you if you’ll generate enough profit to cover the costs of refurbishments or opening a new store.

Say your forecast sales figures for March and April will be down on previous years, as a result of continued low national economic growth, the global financial turmoil or the arrival of a new competitor in the market. You might need to arrange short-term finance to tide you over or find ways to increase sales to cover your monthly overheads and operating costs.

In summary, your cash flow forecast gives you a future view of your business finances. It helps you identify cash flow problems before they materialise and allows you to make informed business decisions.

How to create a cash flow forecast

You can use your computerised accounting package, a spreadsheet program such as Excel, or download a cash flow forecast template to calculate your cash flow forecast. Most accounting packages will be able to pull up many of the figures you need to put into your forecast directly from your accounts, saving time and effort.

Step one

Enter your opening bank balance, which reflects the amount of cash you have on hand.

Step two

Identify the money coming into your business over the next 12 months (most forecasts cover the year ahead). It could be credit sales you’ve already made, any forward orders you’ve received and projections of future sales based on past performance or market research. You might adjust these slightly by increasing or decreasing them by 10%, or a similar percentage, to allow for anticipated growth or tighter market conditions.

Step three

Record the expenses you’ll need to pay each month. This will include your overheads or fixed costs, your variable or operating costs, any one-off purchases and annual payments, plus any money you’re likely to draw from the business.

Step four

Add your income to your opening bank balance and subtract your expenses. This is your closing bank balance each month – repeat for the year and you’ll have an appreciation of your business’s likely cash position for the year ahead.

If your forecast bank balance at the end of each month is positive, you have sufficient cash flowing into your business to meet your expenses. If your bank balance is negative, you’ll need to source additional finance to keep your business running and look at ways to increase sales, reduce costs, or both.

The hardest part of creating a cash flow forecast is working out accurate income and expense figures for the months ahead. Obviously, the more accurate these figures are, the more accurate your predictions will be (and the business decisions you base on them).

For your forecasts to continue to be of use, you need to update them based on your actual business performance each month. Replace your forecast figures with the exact data for the month and make adjustments to the next few months’ forecast figures if it appears, based on reality, that your projections were either overly optimistic or pessimistic.

Putting your forecasts to use

Apart from giving you a reasonably good indication of your likely cash position at any point in time and alerting you to potential problems (which will enable you to act in advance, rather than react), your cash flow forecasts can be used to model your plans.

Let’s say you plan to open a new store. You can put the additional expenses into your forecasts to see if you can afford the upfront expenses. Then you add the extra revenue you expect to receive to see the overall effect on your business.

You can run three versions of this forecast: a worst-case, best-case and middle-of-the-road scenario to see how this will affect your business finances. These forecasts will help you decide whether to open the new branch or not. If you’re uncertain you’ll achieve your best-case sales, and your middle-of-the-road figures don’t look that promising, you might decide to wait a year before you open the store or elect to open a virtual shop front and sell online instead.

Alternatively, you might discover it’s better to use any surplus cash to pay off interest-bearing loans.

Once you have your forecasts set up, use them to model “what if” questions about your business to help you make the best decisions for your business.

• • How often should you upgrade and review your forecasts?
  • How can your accountant help and work with these forecasts?
  • Should I ask Connolly & Associates accountants to do these for me?
  • Is my cashl flow at risk in the near or far future
  • Does Xero help populate these forecasts? (Can we add another blog for this?)
  • If your cash flow isn’t looking positive, view our article on Dealing with Cash Flow Problems or contact our accountant’s team today.