Cash flow problems can occur within any business, whether it be late payments causing a knock on effect to your outgoings or over supplying for low demand, every business could fall victim to cash flow problems at any time within their lifetime. So what can be done to manage your cash flow more effectively?
When it comes to running a business, cash flow forecasting should be at the top of your priorities. Keeping on top of your cash can ensure the health of your business is maintained and can open up opportunities to grow.
We have created a free downloadable cash flow forecast template to help keep your budget and spend on track. All formulas are pre-created, just add your own financial information in!
Cash flow forecasting is a plan or estimate of a company's financial position in the future- it shows what money will be coming in and going out of your business for a set period. Usually, based on annual figures, a cash flow forecast should be monitored closely each month. It will typically look at incomings, outgoings, loans, sales, expenses; every penny passing through your business for whatever reason should be included in your cash flow forecast.
Cash flow forecasting is an attempt to estimate future growth and outcomes based on past events and management insight. It aids with budgeting and planning for a company in advance and should be part of any company’s financial structure.
A cash flow forecast is different from a profit forecast because profit is based solely on when income is earned and when costs are incurred, whereas a cash flow forecast is based on when income is received and costs are paid for.
For example, Company A makes £1,000 worth of sales in January, due to 30-day credit terms, only £500 is paid for in the month, the rest is received in February. The company has £500 of costs in January, all paid for in the month. Below is how those figures would look in the different forecasts.
A cash flow forecast can very high level or very granular, this will depend on your requirements. However, the 3 main constants that should be in every cash flow would be the cash balance, receipts, and payments.
Your opening cash balance in the first period will be the actual bank balance at the start of your forecasting. Your opening cash position for subsequent periods will be your closing cash position from the prior period.
Before you can start your cash flow, you will need a forecast or estimate of sales for the relevant period that your cash flow will be covering. Looking at previous years’ sales and trends are often a good place to start. Once you have your sales forecasts in place you will need to apply the ‘expected payment period’ to these sales. This will vary from company to company depending on payment terms given and efficiency of credit control. You should record when you expect to receive these receipts into the relevant period, adding them to your accounts so they are reflected in the closing cash position. Please see the example below:
The final part of the cash flow is to now estimate outgoing payments. Most businesses will have both fixed and variable costs. Fixed costs such as wages and rent would be expected to be consistent payment values and dates each month. Variable costs such as commissions and production supplies will be dependent on your business and will likely involve a bit more work to estimate. Both will need to be included within your forecast. Any future capital expenditure should also be considered here.
Taken to a more granular level the above may look as follows:
Through forecasting, you should have a good idea of when invoices are going to be paid by your clients and how much money you will have floating within your business. This, in turn, enables you to plan what you can do with your business. For example, after paying your suppliers and other costs, you will know if you have enough money left in the bank to invest in some new office equipment or not before the money coming in.
Apart from accounting for every penny that comes in and out of your business, there are other advantages to a cash flow forecast:
Forecasting allows you to spot cash gaps before they hit your business, allowing you a suitable time to cover this dip in your cash flow. By seeing this in advance, you are also able to take action before it hits. It may mean cutting operating costs or holding out on updating your equipment until you’re in the clear to save the cash shortage damaging your business. You could even change some customer payment terms or look for alternative finance options, but the most important thing regarding a cash shortage is that you’ll see it in advance with efficient forecasting.
If your cash flow forecast keeps falling short each month, this will highlight late payers within your portfolio, making you aware of what clients are affecting your bottom line. Your forecast allows you to see how much should be coming in if everything was going to plan, so you will quickly spot any downfalls if figures aren’t met and it would be easy to identify the culprits that need a more effective credit control.
Cash flow forecasting can also help you track your outgoings from the business without doing it manually. For example, if you have a set figure that’s due to leave your business every month such as payment for utility bills, you can calculate your guaranteed total outgoings. If that number is higher than it should be, it will affect the total paying out figure and you will be able to identify what area of the business you are overpaying in fairly easily as its all monitored. If it wasn’t for forecasting, you may not have noticed this error if you had manually checked.
Having a cash flow forecast allows you to run through hypothetical business scenarios and assess their impact. For example, if you decided to expand into another country, you can forecast your cash flow to see if you'll be able to afford it using real data and figures. Using a detailed cash flow forecast will enable you to change independent variables and make informed business decisions based on what works best for your business.
There are many advantages of using a cash flow forecast, but it is mostly for protecting your business by trying to spot any warning signs well before they occur. Cash flow forecasting is a glimpse into the future of what your company could achieve with the back up of data to support your business decisions. Creating your cash flow forecast doesn't have to be a daunting task, follow the steps above of what it should include and build on it if your approach needs to be more detailed. You can trial it for a few months and adapt and change as you go.