Why every business should have a cash flow forecast & how to build one?

Cash flow forecasting is one of the most useful financial tools for any business but the problem occurs when business owner’s mark it much down on their priorities list. Many of the surveys found that business owners don’t have any full proof plan to manage their cash flows. Most of the businesses believe that cash forecasting is only relevant for large businesses but they don’t know that particularly in this time of COVID-19, it is relevant for all the businesses. Cash flow forecast not only gives you proposed picture of your business but also help you in managing your cash flows better. Forecasting of cash flow is a relatively simple process. It’s just how a business owner requires it depending upon their needs and the business size.

• What do you mean by cash flow forecast?
• Why cash flow forecasting is important?
• What are the steps you need to take to manage your cash flow?

What do you mean by cash flow forecast?

Before going further to understand what cash flow forecasting is, we must know the meaning of cash flow – Cash flow means moving of money either coming in or going out of your business. It shows the real time picture of your cash you are paying or receiving every month. Cash flow forecasting is a plan made specifically to predict the future cash position of the business. Cash flow forecasting helps you by identifying how much cash you are expecting into your business or how much you are paying out of your business in a specific period of time or in the coming future.

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Why cash flow forecasting is important?

Cash flow forecasting is one of the most valuable financial tools to identify the future cash flow position of your business. You might currently have enough cash available but have you analysed that this current position will continue to remain the same or will you have to face challenging times in the coming future. Cash is the most important component of a business which not only makes your business position strong but also helps in future growth of your business. Therefore, it is very important for you to understand and identify what changes your cash position will take in the coming future. You can plan and easily analyse your future cash needs with the technique of cash flow forecasting and take appropriate action to prevent you from being cashless. Cash flow forecasting gives you proper knowledge and understanding of future income, costs orders, debts etc. and present a clear cut picture that in which direction your business is going on and what appropriate steps you should take now in order to change its position further (if going in a wrong direction). You can easily take much informed decisions by understanding the current and the future cash flow position of your business. Cash flow forecasting tool is used by many external parties such as investors, funders, banks and even creditors like HMRC when you agreed upon a payment plan.

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What are the steps you need to take to manage your cash flow?

1. Step – 1: Understand your business

   – Firstly, you must analyse the performance of your business to identify potential risks, problems and opportunities which may come in future. It is necessary for you to know where your business stands today and where it is going, so that you can easily take important decisions in support of your business and cash forecasting will be the key. You must take the following steps in order to understand your business properly –
   1. Keep your accounting records up to date to predict the future cash flow demands.
   2. Try to make more informed decisions to get clearer picture of your business.
   3. Timely review of existing system of bookkeeping and reporting.
   4. Simple accurate reporting – monthly, quarterly, yearly but it should not be complex or time consuming.
   5. Updated accurate data from accountant - if not, you must talk with your accountant to identify errors.
   6. Use cloud accounting software packages which may come along with reporting tools so that you can easily access past cash flow movements of your business, identify the trends and project forward.

After completion of review, you can easily access how much cash is available and how much is trapped. Use this information to predict the future cash needs of your business.

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2. Step – 2: Do the cost review

   – It is very important for you to make control over your business related costs. You may have times where you have cash flow pressures but cost controlling is such that you need to maintain at every business stage. Determine the cost – whether fixed or contractual, what cost you can reduce or whether you have made any discretionary spending etc. When you analyse and make differentiation between fixed, variable, contractual and discretionary costs, you will be in a more favourable position to understand the difference between them as well as more able to predict the fluctuations that may happen in future. Consider the following tips -
   1. Try to make payments on priority.
   2. Identify how much you can save or reduce.
   3. Give more priority to key suppliers and relationships.
   4. Analyse and give attention to the biggest fixed costs i.e. staff costs and understand your future staffing needs.
   5. Do not forget to make other important payments such as assets purchases, finance payments, loans repayments, tax payments, drawings, VAT payment (If you are VAT registered) and payments to other creditors.

3. Step – 3: Make future income projections

   – Looking ahead and predicting your future income by analysing previous income levels is also an essential step to start with. There are many things that you need to analyse in order to determine your future income levels. Analyse how many short or long contracts you are engaged in, whether you are getting any seasonal income or how much payment you think that you will receive and when it will be going to take place in the near future. After analysing all these points, start your income prediction for the coming period. Identify your cost needs in case of income change and also revisit your cost plans. Keep your focus on variable costs that fluctuate with sales or any asset purchases. While doing future income projections, the most important question which you need to answer is – when your payments are expected from your customers? If your customer is not paying you on time, it is considered as one of the biggest cash flow issues. Try that your all customer must pay you on time; make this a part of your plan. You can even call your customers (If needed) to understand their future plans. In order to protect your future cash flows, offer them payment plans/discounts and influence them to pay early.

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4. Step – 4: Forecast your cash flow

   – Now, you are ready with your costs and income, focus on what cash flow forecast will help you with and who will use the forecast – whether it will help in taking short term decisions or making long term strategies, detailed cash management etc. and whether it will use for internal purpose or to support back funding. You also need to work out the time period for which you are going to forecast – Few days, 3 months, 6 months, or 12 months. As per suggestion, please focus on 12 months period, you can also give preference to 3 or 6 months period. After answering to these questions, choose a cash flow model as per your suitability. Try to choose a simple cash flow template, it should not be complicated. Many cash flow templates are available online; make sure that they serve your purpose. In case you are unsure about the best option, you can talk to your accountant also. You should also assume the worst case scenarios while forecasting your cash flow. In worst scenario, under-estimate your income and over-estimate your expenses. Work on all scenarios and see what results you will get at the end of the period.

5. Step – 5: Access support and funding

   – In case you are having a cash flow shortage or you have just started your business or looking for growth, cash forecasting can help you in identifying your cash needs so that you can take the much needed support or funding from the available sources. You are having the following options with you to consider –
   1. Talk to the existing bankers/funders in order to meet your cash needs.
   2. Look out for alternative funders.
   3. Use Government grants & schemes to meet your cash needs (Various schemes for start-ups and growth are available)
   4. You can also discuss cash issues with your staff, suppliers, landlords, customers.
   5. Communicate with your stakeholders to meet your cash goals.
   6. Talk with your accountant as they should have a broad view of the funding market and can recommend you more options for finance providers.

6. Step – 6: Continuous reviewing and updating

   – Cash flow forecasting is a useful tool to estimate the future assumptions and trends but it will never give you perfect figures as it is very difficult to estimate. Continuous review of your estimated cash flows and its comparison with actual cash flows will show you the accuracy of your projections. You can also take a look upon the trends your cash flows are following from the past to the current period.
   Keep your cash flows updated with the latest financial information and review the assumptions from time to time for amendments and to arrive at better decisions. You will see that comparing estimated cash flows with actual cash flows help your forecast to be even more accurate in the coming times.

If you have any queries or want assistance in the planning of cash flow forecasting, please call us on 03300 88 66 86 or you can also e-mail us at enquiry@dnsaccountants.co.uk

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About the author

Gary Zouvani
I am a qualified chartered management accountant with over 25 years’ experience working in industry and accountancy practise. Currently DNS group operations director I manage over 50 employees as well as head up our accountancy franchise proposition.