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How did you know what to wear today? It’s likely you turned on the weather forecast, which told you whether it will be hot or cold.
From that information, you were able to pick either a warm winter coat, or perhaps a pair of shorts depending on what the forecast told you.
When it comes to your business, a similar tactic exists called cash flow forecasting.
But, instead of telling you what to pick from your wardrobe – it actually tells you about the outlook of your business, so you can prepare for what lies ahead.
Cash flow forecasting is an excellent tool for anyone who is self-employed or runs their own business.
The goal is to ensure there is enough cash flow to cover expenditure, as well as generate profit once expenses have been deducted.
Another benefit of cash flow forecasting is to better manage capital within the business.
This includes debt reduction as well as ensuring the business is running efficiently.
For example, identifying any unnecessary costs that could jeopardise cash flow or profit.
Here is everything you need to know about cash flow forecasting, including why it’s important for your business and how to get started with creating your own.
What Is Cash Flow Forecasting?
Cash flow can be defined as the money going in and out of a business. Predicting cash flow is not the same as showing actual profit or loss.
Instead, it estimates what both of these are likely to be, ahead of time, based on previous data or current calculations.
Your cash flow considers both the inflow and outflow of cash. For example, your inflow could be the amount of customers who buy a product or service from you that month.
Your outflow can cover everything from rent to wages and other business expenses. What you are left with at the end of the month would give you that final figure.
How you prepare for both the inflow and outflow ahead of time, is by cash flow forecasting.
This is a method that gives you an accurate prediction of your expected figures, by taking both the inflow and outflow into consideration.
The forecast is normally presented via a chart, and can also be created easily using an Excel sheet.
You can create a cash flow forecast either a year in advance, or even in 3 month increments depending on the nature of your business, and how far in advance you wish to project.
Why Do I Need A Cash Flow Forecast?
The best way to explain cash flow forecasting is to compare being employed vs running a business.
For example, if you are an employee earning a regular wage, you know how much you will be paid, and can work out your expenses just by looking at one wage packet.
This includes how much you need to pay your mortgage or bills, as well as how much will be left over to spend or save.
The amount rarely differs unless you also become self-employed, so earn more in a particular month, or perhaps take unpaid leave so you will earn less than usual.
When running a business, however, that principle works completely different as you will not have a fixed income each month.
Some months your business may perform better and so there will be more cash flow within the business, and other months there may be less which could create difficulties paying your staff and similar expenses. Unless, you plan ahead via a forecast.
By predicting your cash flow in advance using a forecasting method, you will be able to calculate how your business will perform ahead of time.
The reason this is so important, is because it enables you to see any upcoming challenges to the business, and deal with them before they become a risk to your business.
It can also prevent you from spending or investing too much of the profit from a good month, when the month that is set to follow could generate a loss.
An Example Of Cash Flow Forecast In Action
Let’s take our imaginary florist ‘Petal Delight’ an example model. In February, the business is forecast to earn £26,000 gross profit, due to Valentine’s Day.
In March, they are forecast to do even better taking £35,000 because of Mother’s Day.
However, their forecast for April-June (where there are no national days where people would rush to buy flowers), shows the gross profit is likely to average at just £11,000 a month.
That dip in profit is to be expected, due to the nature of the business and when people typically buy flowers in abundance. However, there are now steps the business could take to lessen the gap, now they are aware of a potential profit drop.
After all, they still need to pay staff wages, rent and other costs associated with running the business, even during quieter months.
For example, by creating and analysing the cash flow forecast in advance, the florist can work with the marketing team to create promotions to boost sales.
It also helps to balance out quieter months of the business, so that the owner does not overspend during profitable times, which could put the business at risk during slower periods.
This is another reason cash flow forecasting is useful, because it can show when you have surplus cash to either invest into the business, or save for quieter months.
If the cash flow dips too severely this could put the business at risk.
However, if you have saved the money from months where the business has exceeded, this will cover the deficit. Without financial forecasting this would have been impossible to predict.
Making Your Business More Efficient
Cash flow forecasting is also useful to see if you are wasting money anywhere in the business. Going back to ‘Petal Delight’, our cash flow forecast has established the business has its busiest period throughout February and March.
Throughout this time, the business hires 3 additional staff members to cover demand. However, there is no need for more staff during most of the year, so if the business continues to pay their wages when there isn’t any work for them, this would actually be a detriment to the business, and could put it at risk.
Instead, a better solution would be to hire temporary staff which would reduce the wages paid, saving the business money. Without consulting the cash flow forecast, staff could have easily been given work when there wasn’t any for the business to facilitate this, causing a loss.
Therefore, cash flow forecasting looks at expenditure as a whole to ensure the books can be balanced. This is especially useful if your business has significantly varying levels of inflows throughout the year.
How to create a cash flow forecast
To create a cash flow forecast, you first need to look at your bank statements. Not only will this give you an idea of how much you are earning each month, it will also give you an estimate of which customers are going to pay you and when.
The figures used in your forecast may actually originate from your bank statements. This includes how your business has performed throughout each month, to give you an idea of how it is likely to perform throughout the same period next year. The actual figures may differ if your cash inflow/outflow is expected to change, but it will at least give you a starting point.
You can either create the forecast on Excel, or by using an app such as Float. If you are creating a traditional spreadsheet, here’s an example of what that might look like:
|Cash at start of month||25||20||15||5||10||20|
|Net cash flow||-5||-5||-10||5||10||5|
|Cash at end of month||20||15||5||10||20||25|
In our example, we have a list of months each showing the cash at the start of the month, how much money is going into the business (inflows), how much is going out again (outflows), the net profit and finally the cash that’s left at the end of the month.
Each of these key figures plays a part in the cash flow forecasting, as it gives a reason behind the overall figure. For example, the cash at the end of the month might be low because there wasn’t a high enough cash inflow. Seeing this prediction in advance would allow you to create a strategy to remedy the situation, especially if the following month isn’t predicted to compensate for the loss.
Likewise, being able to predict your cash flow at the end of the month after all other expenses have been paid out, gives you an idea of how well your business is performing. If your cash flow at the end of the month is set to be very high in February but very low in April, it gives you hindsight to be able to prepare for this.
Cash flow forecasting allows you to predict how your business is going to perform in the future, so that you can best prepare for any significant changes in cash inflow or outflow.
By having this information well in advance, you have time to save money from a particularly profitable period to cover the losses without it affecting your business. Similarly, you can also create a strategy (such as new marketing tactics) to boost trade during slower months, well before the dips happen.
Your cash flow forecast will also give you insight into any unnecessary spending throughout the year, which may be resulting in a low amount of cash left at the end of the month too.
Ultimately, by creating and analysing the results of your cash flow forecast, it will allow you to make better business decisions. For example, not taking on additional staff members when the budget will not allow for it. Or, avoiding overspending after a profitable month, when you are set to make a loss the following one.
By understanding your cash flow forecasting, it will ensure business health as well as long term growth, if you respond appropriately to the projected figures.
Want to read more about running a business? Check out my free guide which covers all of your top questions to get you started.
Anita is a Chartered Accountant with over a decade of experience taking self-employed business owners from financially confused to business savvy.
She is the creator of the ‘Go Self Employed’ website, which is her corner on the internet where she makes self-employment less terrifying.