Cash flow forecasting is vital for any business.
It tells you about the viability and health of your business on an ongoing basis. As such, it’s one of the core financial documents every business should have.
In this article, we cover everything you need to know about cash flow forecasting, including the following:
What is a cash flow forecast?
Let’s start with explaining what cash flow is.
It’s a measure of cash flowing into the business, typically via sales, offset against the money flowing out of it, such as salaries or rent.
The goal is to ensure the former is always greater than the latter.
Most businesses naturally ask how to forecast cash flow – to see what it will be like in the future, so they can make plans for growth, or at least ensure there’s never a shortfall where the cash going out is more than that coming in.
A cash flow forecast provides the answer.
Sometimes known as a cash flow projection, it estimates your cash flow on a month-by-month basis.
Most cash flow forecasts aim to project out to a year from the current date. So, you can see at a glance what your business might expect to be spending and receiving in, say, six months’ time.
How to do a cash flow forecast needn’t be complicated.
Many people create a cash flow forecast within a spreadsheet, and you’ll find a ready made cash flow forecast template in our free Small Business Toolkit. If you’re using cloud accounting software, you might find the feature is built-in, perhaps in the form of a report or dashboard.
Why is a cash flow forecast important?
There are two reasons why a cash flow forecast is important.
Want to know if you can afford a new van, or to move into new premises? A cash flow forecast will tell you when this will be possible – or if you need to make changes to how you work to make it possible.
The second reason cash flow forecasts are important is that investors or banks providing you with money will want to see the document.
They’re interested in the same things you are – which is to say, your projected liquidity and growth.
But the fact you even have a cash flow forecast is also what they’re looking for. Maintaining one is simply one sign of a well-run business.
What does a cash flow forecast show?
Usually, it’s split into two sections. The top half shows incoming cash, and the bottom half shows outgoing regular payments.
It’s usually further split into estimated vs actual columns for each month, with the idea that you can fill in the latter once the month in question has ended to see how accurate you were – which can then inform further cash flow forecasting.
On the free Sage Advice cash flow template, we’ve named the incoming sections ‘Receipts’ and the outgoing section ‘Cash Payments’. These are also referred to as A and B.
At the bottom of the two sections is a Net Cash Flow box – which is A minus B – and the goal is to ensure this is always positive.
Some months it might not be, of course, which is fine – provided you’ve made plans for this to happen, such as by arranging an overdraft.
Of course, it’s not enough to merely enough to create and maintain the cash flow forecast. You need to know how to analyse it, especially if you’ve created it with the help of somebody else such as an accountant.
You should be able to glance at the forecast and understand the data – and be sure it’s accurate. It should be updated as frequently as any of your other key financial documents.
If you lose or gain a big sale, for example, then that should be reflected immediately in the forecast moving forward.
How to use a cash flow forecast template
Here’s how to complete a cash flow forecast.
1. Accruals vs cash accounting: A quick overview
There are essentially two ways of recording income and expenditure in a business. The first is where you record money when you get it, and when you spend it. This is known as cash accounting.
Or you might record income and expenditure as they’re incurred – when you issue the invoice for a sale, even though you won’t necessarily get the money from the customer for a while thanks to 30-day terms.
But at least the sale will be listed near to the expenditure, making it easier to see what’s what.
It might sound like accruals accounting is best for forecasting. And it is. But not when it comes to cash flow forecasting.
The clue is right there in the title – this is about forecasting the flow of cash.
You should only be detailing income and expenditure in the forecast when you expect it to be received or spent.
This might mean you have two or more entries in the forecast each month for incoming cash – one for sales for which you receive cash immediately, and another entry for receivables, which is to say, money that’s come in that you’re owed, most likely from previous months.
2. How to calculate the opening balance in a cash flow forecast
The opening balance on a new cash flow forecast is simply your bank balance – but with a caveat.
You should make the first month in your new cash flow forecast the current month you’re in (which, obviously, will not yet be complete).
So, if you create the cash flow forecast in March then March will be your first month.
Therefore, in the opening balance field, you should simply input your bank balance – but from the start of the month. Look to your bank statement to find this.
The opening balance for each subsequent month should be calculated based on the bank balance plus the net cash flow figure from the previous month.
Most cash flow templates will automatically complete this based on the previous month’s data.
3. How to calculate sales in a cash flow forecast
You should try to be accurate when projecting cash coming in through cash sales receipts (those for which you receive the money immediately).
A good way to do this is to look at your sales figures from the same period in previous years, and then look at how they rose (or fell) compared to the same month in the ensuing years.
Try to identify patterns.
Of course, if yours is a new business, this will be impossible and you’ll have to make estimates based on best guesses. But these can be corrected as time goes on and you generate sales data. Also, don’t forget seasonality in your projections.
You can aggregate all your product sales into a single figure within the forecast, or split products out on the cash flow forecast if you desire that degree of granularity.
On the whole, though, it’s good to keep things simple. Don’t forget that the cash flow forecast is intended to be a summary.
4. How to calculate receivables in a cash flow forecast
This one is slightly easier to calculate from the get-go on a new forecast because all you need to do is examine your existing invoices and terms, plus any sales contracts.
For example, if you made a £500 sale last month on terms of 30 days, it’s safe to enter this into the receivables field for this month. You can use the length of the contract you agreed to project that out over the coming months.
Remember that you might need to add in time for payments to clear too. There might be an effective payment term of, say, 30 days plus a couple more days until the payment actually appears in your account.
Don’t forget to project for all sources of income and not just sales.
You might be in receipt of grants from the government, for example, or your accountant might tell you that you’re due a tax rebate at the end of your accounting period.
Remember that it’s not just about sales vs expenditure. This is about all cash coming in and out, regardless of where or why.
5. How to calculate expenditure in a cash flow forecast
You should aim to record expenditure you expect to make in the months you make the payments.
Again, if your business is established, this shouldn’t be hard to project based on existing bills and invoices you’ve received.
Aim to record everything, including rent, utility bills, supplies, vehicle expenses such as fuel, and so on.
The list might be surprisingly long.
Remember that the goal is to record the payment when it’s going to be made.
In other words, if you pay your £1,000 electricity bill quarterly then you should include the full £1,000 payment in the month it occurs.
Don’t be tempted to take the payment and divide it by four to spread it across the relevant quarter because, again, that’s not how a cash flow forecast works.
If you do that you’re not accurately recording the cash flowing out of the business when it occurs.
Some regular payments might be yearly, such as insurance. Again, record the lump sum at the time it’s paid.
This is why cash flow forecasts can be so invaluable.
If you add a projected £500 spend on marketing in a particular month, but find you won’t have the cash coming in to pay for it (or savings in the bank), then you have an issue.
Therefore, you can postpone the spend, or renegotiate with the supplier to perhaps pay later, or pay less. You might arrange an overdraft with your bank.
But the key thing is that you’ve seen the problem from afar and can prepare well in time.
6. How to work out the closing balance on cash flow forecast
The closing balance for each month is simply your opening balance plus (or minus) the net cash flow figure.
In other words, if you open with an opening balance of £10,000 and the net cash flow shows £300, the closing balance will be £10,300.
Or if you open with a figure of £800 and the net cash flow is £900, the closing balance will be -£100 (sometimes negative figures are indicated in financial documents by being within parenthesis).
This closing figure then becomes the opening balance for the next month and, with most cash flow templates, the figure will be transferred across automatically.
How does a cash flow forecast impact other financial statements for a small business?
The cash flow forecast should sit alongside your existing income statement (also known as a profit and loss statement) and balance sheet. All the documents will inform one another, and you’ll probably have all three open at the same time – and be updating all three at the same time too.
It’s very easy to neglect the cash flow forecast if your time is pressed. It might feel as if the balance sheet is more urgent – and in some ways it is.
But while the balance sheet ensures your business health in the here and now, the cash flow forecast really does ensure its ability to endure in the months ahead.
It’s the best tool by which to not only predict problems but also plan for growth.
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