How to build a cash flow forecast

An accurate cash flow forecast is vital to running a business of any scale. From the largest multinational to startup SMEs (Small-Medium Enterprises), cash flow forecasting is critical to maintaining a good grip on your finances and planning ahead.

In the UK alone, 90% of businesses fail because of inadequate cash flow and the inability to access the right capital in time. In the U.S., surveys indicate that most SMEs work on incredibly small margins, with only 58% reporting that they have enough working capital to last three to five months.

These issues are exacerbated by the current and ongoing late payment crisis. A survey by QuickBooks shows that 81% of businesses report consistent late payments and that the average business is owed $304,066.

Despite the importance of these issues, survey data by Clutch indicates that more than half of small businesses do not have a documented budget, let alone any evidence of cash forecasting.

So, if you're looking to get a better grip on your financials and learn how an accurate cash flow forecast can help your business, read on.

Cash flow forecasting empowers you to stay one step ahead of potential cash shortages. By identifying and addressing these gaps proactively, you can maintain financial stability and drive your business forward.

What is a cash flow forecast?

Let's start with a breakdown of precisely what a cash flow forecast is and how it works. A cash flow forecast predicts how much money you will have coming in and out of your business over a given period.

It is generated by considering all of the transactions your business carries out, from payments to suppliers and wages to sales income. It can be set up on a daily, weekly, or monthly basis, depending on the size of your business and how frequently you need updates.

Cash flow projection is an invaluable tool for business owners that can help you plan ahead, identify any potential cash flow issues and even access capital early if needed. It also helps to inform decision-making about current operations, budgeting for future projects and can even be used to help secure financing from external sources.

Cash flow forecasting examples

Now that you've got a clearer idea of what a cash flow forecast is, let's look at some examples to clarify how it works.

Say you're a small business owner that sells products online. The elements considered in your cash flow forecast might look like this:

This simple example shows that the predicted cash flow for this business is a positive figure of £250 over the given period. This money can then be used to cover additional costs and expenses, used as working capital, or put towards other investments.

This video shows a run-through of the key elements you should consider when preparing your cash flow forecast, and how to build a cash flow forecast in excel or google sheets.

Let's look at another example over a more extended period.

For a five-year period, a cash flow forecast for a business that manufactures and sells its own products might look like this:

This example shows that the predicted cash flow for this business is a positive figure of £95,000 over the five-year period. 

It's important to note that it is usually best to forecast conservatively when it comes to income, such as investments, as you may not get the expected return.

To start building your own business’ cash flow forecast, you can use this cash flow forecast template from the British Business Bank.

Why is cash flow forecasting so important?

As we've already touched on, the main reason that businesses fail is because of a lack of cash flow. Without access to liquid working capital, businesses can find themselves in a position where they can't pay their bills on time, invest in new products or services or expand operations.

At best, a lack of cash flow will limit growth and profitability. At worst, it can cause the business to go under.

These issues are made worse by the consistent late payment crisis being faced by businesses of all sizes. Ensuring consistent cash flow is no longer as simple as ensuring you've sent out your invoices. You need to anticipate what money is coming in and when it might arrive, considering factors like customer payment behaviour and its effect on payment timelines.

Accurately forecasting cash flow allows businesses to identify any potential risk areas and take steps to mitigate them before it’s too late. With a suitable cash flow forecast in place, businesses can anticipate when money will be leaving their accounts and when money will come in.

By creating and using an accurate cash flow forecast, you can avoid common pitfalls and stay ahead of the game.

A cash flow forecast will help you to:

• Identify potential cash shortages
• Recognise areas where funds can be saved
• Make informed decisions about future investments
• Develop strategies to increase cash flow
• Anticipate slow-paying customers and plan measures to manage the situation
• Identify opportunities for additional income
• Access financing in a timely fashion

As you can see, all of the functions of cash forecasting provide a material benefit to businesses of all scales. By proactively monitoring the cash flow of their business, owners can increase profitability, sustainability, and security.

How to create an accurate cash flow forecast

Now that we've highlighted its many benefits, the good news is that creating a cash flow forecast is actually pretty easy. Let's walk through it, step by step:

Step one: Forecast your business income

The first step in creating your cash flow forecast is to decide on your reporting period. Monthly is the most common option, but you can also choose to create forecasts on a quarterly or even annual basis. It is, however, worth noting that the longer the forecast, the less accurate it is likely to be.

Once you've chosen your period, look at your records for the same period late year and use those sales figures as a benchmark. This will give you a baseline from which to forecast future income.

Look for patterns and trends in your sales data and use them to forecast future income. Don’t forget to account for seasonality, one-off orders, and any other factors that might affect your sales. 

The further back your records go, the more data you can use during this step and the more accurate your forecast is likely to be.

Step two: Estimate your cash inflows

Your next step is to estimate your sources of revenue that don't include sales. These are often referred to as 'cash inflows' and might consist of the following:

• Loan repayments
• Investment returns
• Income from the sale of assets such as property or machinery
• Government grants and subsidies
• Tax rebates
• Royalties, franchise fees, or license fees

It's essential to underline that these cash inflows do not include your predicted sales, only non-sales-related sources of income. 

Step three: Estimate outflows and expenses

Once you've calculated your cash inflows and estimated your sales revenue based on historical data, the next step is to estimate outflows and expenses. This includes both fixed costs such as rent, salaries, and other non-negotiable payments, as well as variable costs like marketing expenses and advertising.

Step four: Compare estimated inflows and outflows

Your final step is to calculate your net cash flow by subtracting your total estimated outflows from your total estimated inflows. This will give you an idea of whether your business is expected to have a cash surplus or deficit during the designated period.

It's important to remember that creating an accurate cash flow forecast is an ongoing process and should be revisited regularly to consider changes in the business environment, customer behavior, and payment timelines. 

It's also worth noting that, while cash forecasting is an essential tool for managing your business finances, it should not be used in isolation. If you want to ensure the long-term success of your business, it's vital to consider other elements such as budgeting, cost management, and strategic planning.

Building a cash flow forecast for your business

Building your cash flow forecast is a simple task with wide-ranging benefits. When done correctly, cash flow forecasts can provide valuable insights into your business's current and future financial state and help you make informed decisions on how to manage your finances best.

Used in conjunction with budgeting, cost management, and strategic planning, it can be an invaluable tool for driving growth, increasing profits, and ensuring the ongoing success of your business. With a suitable cash flow forecasting model in place, you can optimize working capital to improve efficiency, reduce costs and, in turn, increase profits.

To get started on building your own business’ cash flow forecast today, you can use this free cash flow forecast template from the British Business Bank. We also recommend this video on how to create a cash flow forecast for further guidance.

Combined with making use of tools such as accounts receivables automation to overcome the obstacle of consistently late payments, cash flow forecasting can be a powerful tool for financial success. 

To find out more about how Chaser can help you both reduce late payments and provide you with valuable data to improve your cash flow forecasting, contact us today or start your no-obligation 14-day free trial today!