Planning for the future using cash flow forecasting

Have you ever worried about not having enough money to cover your business expenses?

Cash flow management is a challenge for many small business owners, who still have to pay the bills even when they’re waiting to be paid themselves.

Cash flow forecasting is a form of risk management that can help you to prepare for the unpredictable by pre-empting risk. It involves revisiting the past, looking at the present, and setting realistic financial goals.

This article explains how a simple cash flow forecasting exercise can ensure your cash reserves never dry up.

Here’s what we cover:

What is cash flow forecasting?

Cash flow forecasting is a process of estimating how much cash is flowing into and out of your business over a specific period.

It helps you to run your business more efficiently while being able to anticipate slow and busy months.

A cash flow statement includes all your projected expenses and income and helps you to predict months when you’ll have more than enough cash—or not enough—to pay the bills.

When you know your cash position, you can make better decisions, like if you can afford to buy new equipment or hire a new employee, or if you need to take out a small business loan to get through a tight patch.

When you compare your actual income and expenses with your forecasts, you can see if your business is doing better or worse than you thought.

For example, if your sales are higher or lower than expected, you’ll want to figure out why.

Have any of your competitors changed how they do business?

Have new competitors entered your market?

Has your customer service or quality control dropped?

This kind of active business management gives you the power to ask the right questions and, in the end, make the right decisions.

Usually, the forecast will cover an entire year, but you can also create estimates for a shorter period, such as a month or week.

Here’s how to do it.

Compile 3 comparative figures

1. Same month, previous year: What were your income and expenses figures for the same month last year?
2. Same month, current year: What are your current income and expenses figures?
3. Same month objectives: Look at your budget and calculate how much you need to break even and make a profit.

Your past sales can tell you a lot about how much money you can expect to make in a given month.

Be sure to include seasonal patterns and one-time events in your forecasts.

For example, if you sell ice cream, you might be busier in the summer. If you offered taste tests at an ice cream expo, you probably sold more product that weekend.

Remember to include market conditions, trends, and future plans in your forecast.

For example, if you’re planning a marketing drive because you’re launching a new ice cream flavour, you might anticipate an increase in sales.

Similarly, if the artisan ice cream market is exploding, you might want to drop your forecast figures a little to allow for a possible loss of market share.

From here, look at your income and expenses for the last 30, 60, or 90 days and do an age analysis.

A plan for managing your cash flow

Once you have your past numbers, current numbers, and breakeven point, you can start figuring out what percentage of your turnover goes towards your expenses.

First, ask yourself these questions:

• Will I receive loans?
• Do I have capital repayments?
• Have I put money aside to cover VAT?

Put your figures into the following format:

• Turnover with the three comparative figures
• Cost of sales percentile (percentage of turnover that will be used to cover expenses)
• Capital inflow (loans)
• Operating expenses percentile
• Capital repayments of previous loans
• VAT figures
• Total outflow
• Net cash inflow and outflow
• Opening cash balance
• Closing cash balance

The completed cash flow management forecast should indicate your estimated yearly growth, how much you need to break even, and your financial capacity to expand your business.

Knowing your breakeven point is the most critical element of cash flow forecasting.

Without it, you won’t be able to make provisions for the busy and slow months, and you may end up making a loss, putting your business at risk.

6 top tips for creating financial security

1. Don’t undercut your costs

You might want to reduce your costs or undercharge to get more clients, but you’ll lose more money and time in the process.

It may seem like charging a premium price repels customers, but the right customers will pay premium prices for high-quality services and a good value proposition.

2. Find additional income streams

Additional revenue streams act as a safety net for your business, ensuring you have a cash cushion to fall back on.

Try to think of an on-demand solution that your competitors aren’t offering. For example, if you’re an accountant, you can provide financial education to young families or start-ups.

If you make ice cream, you can offer workshops for people to come up with their only flavour combinations.

3. Make sure you have a suitable balance sheet

Balance sheets give banks and investors the necessary insight into your business’s financial standing.

Funders will likely reject your loan application without an accurate or comprehensive balance sheet.

4. Don’t over employ

Many SMEs have too many employees for the services they offer, ultimately making a loss.

I suggest having a small, senior team focusing on the high-priority tasks and outsourcing the rest when and if needed.

This way, you have a stable workforce with on-demand help when you need it.

5. Use tech to save costs and streamline operations

Modern digital tools are designed to make processes more efficient and save costs.

For example, cloud accounting software automatically issues invoices and follows up with your customers to ensure you get paid on time.

Meanwhile direct bank feeds pull your transactional data from your bank directly into your accounting system, giving you a real-time overview of your sales and expenses on an insightful dashboard.

It’s also easy to pull historical sales data to compile your cash flow forecast.

6. Turn problems into opportunities

You can’t grow your business without growing yourself. A positive mindset can boost creativity and uncover new ideas to find additional revenue streams, restructure inefficient workflows and systems, and think outside the box.

With digital tools automating the manual tasks, you’ll have more time to focus on growing your business and better serving your customers.

Editor’s note: This article was first published in September 2022 and has been updated for relevance.