The Importance Of Cash Flow Forecasts

Poor cashflow management can be bad news for small businesses. Cash shortages can lead to unnecessary tapping of expensive debt facilities. Worse still, it can impede the ongoing operations of an otherwise strong company.

Simpler than profit forecasting

Every small business needs a cash flow forecast. Cash flow forecasting involves estimating money flowing in and out of the business. It is intuitively easier than profit forecasting which includes estimates of non-cash items such as depreciation. Cash flow forecasts can span any period. One year being the most common.

Where to start

Cash flow forecasts typically start with forecasting sales – sales for which payment is expected to have been received, not just invoiced. Recognise the difference between the two here if your business makes sales on credit because the time between a sale and collecting the cash can widen quickly when times get tough. We would like to have a dollar for every time we have heard “business would be fine if only I could get my customers to pay me!”.

For existing businesses, prior year figures are typically the starting point for forecasting weekly and monthly sales. Take into account any seasonal patterns and build in current trends and market conditions.  Include an estimate of the cashflow impact of any future marketing events you have planned such as advertising campaigns, trade shows and new product launches. Also try to include an assessment of the impact of any such actions from your competitors.

For new businesses, forecasts will need to be constructed from external sources. Industry groups, suppliers, customers and similar companies are all useful sources of information. The Australian Bureau of Statistics also has a wide range of demographic and economic data which may help estimate the size and growth of a target market.

Once you have prepared sales forecasts, calculate your cost forecasts. Again, timing is important and relates to when you expect to pay your bills rather than when you expect to be invoiced. Do your suppliers give you the same payment latitude as you give to your customers? If not, can you take steps to reduce the average number of days that it takes for customers to pay you?

Costs typically fall into the working capital/capital expenditure categories. For example input costs (eg raw materials) are working capital and will be a function of your sales forecasts. A new forklift would be capital expenditure. Costs are also often defined as either variable or fixed but the line between the two can often be quite blurred. Identify other overhead expenses that you will need to pay and when you will need to pay them. A check of historical payments will help ensure that nothing is missed. Don’t forget financing costs – interest paid on debt (less interest earnt on your firm’s bank deposits) - and payments to the tax office.

All that is left to do is to add in the starting point bank balance. The cashflow forecasts will then show the expected state of your bank account at the end of each month throughout the year.

Watch the detail

Remember that cashflow forecasting is fairly straightforward but a quality set of forecasts requires some serious attention to detail. Forecasts should also be constantly reappraised during the year as conditions change. We suggest that the cashflow be updated at least on a quarterly basis.

A key decision making tool

Almost every business decision should be made against the background of high quality cash flow forecasts – forecasts that can be tested for different trading conditions.  For example, a drop in sales or an increase in wage costs.

Positive operational cash flow puts cash in the bank, this leaves the business with the capacity to support spending on relatively lumpy items such as machinery or vehicles. A negative cash flow forecast may lead you to reassess whether that spending is necessary now. Or, it could prompt a pre-emptive conversation with the bank manager.

If you decide to borrow, additional interest expense should be added into the cash flow forecasts. More scenario work would be a good idea here.  What would the additional interest expense do to my cash flows if interest rates rose and sales fell?

High quality cash flow forecasts are a useful check on how your business is travelling. Actual results should be compared to forecasts at least monthly. Is cash flow running ahead of or behind your expectations?  More importantly, why? If sales have missed expectations was it due to a general softening of trading conditions? Discounting by a competitor? A production or distribution problem?  With accurate analysis of the problem, better decision making will surely follow.

Need help?

At Lockwood & Ward we have a wealth of experience with Cashflow Models, and using templates we have developed we can quickly have your Cashflow Forecast up and running. Call us to get started.

Comments are closed.