Cash flow projections and forecast - five steps to preparing a cash flow forecast

An accurate cash flow forecast is a critical tool that reveals the real-time financial health of your business. It measures vital metrics, like: How much cash is coming in? How much money is going out? Are expenses creeping up? How accurate is your projection? A comprehensive and precise forecast can answer these questions and more.

1. Don’t confuse small business cash flow with revenue

Both of these terms are key performance indicators used to evaluate your company’s financial health. Revenue illustrates how effective your company is when it comes to sales and marketing, but cash flow is more of an indicator of your overall liquidity. Your small business cash flow includes revenue, but also sources of money outside your day-to-day sales. Your company often makes money in several ways that don’t rely on how you conduct your operations.

Revenue only measures the amount of money coming into your business with nothing else factored in. Cash flow measures this too, but it also measures cash that flows into or out of your business for other reasons. It is different to revenue because there’s the potential for your cash flow figures to result in a negative value.

A primary reason why cash flow is so important is that it’s a key indicator of your company’s functionality—if you suddenly lost a significant client tomorrow, would you still be able to keep your doors open? Having a sufficient amount of cash means that short-term obstacles won’t get in the way of long-term goals.

2. Identify what’s coming in and what’s going out

While this might be obvious, you can’t run an accurate cash flow forecast without knowing the figures. This forecast details your company’s position in relation to what you have coming in versus what you have going out. To begin, figure the amounts of cash coming in for the time frame you’re forecasting. Where is it coming from? In this equation, you’re not thinking how much you’re able to produce, but instead the payments you foresee collecting for your products or services.

Looking at past years’ numbers for the time frame you’re forecasting is an excellent starting point, but don’t forget to take into account various factors, such as buyer confidence during that past period, as well as confidence in small business, especially if you’re reliant on business-to-business sales. As a small business owner, you know sales aren’t consistent. Opening up lines of communication with other small business owners can help you better gauge these levels of confidence, giving you valuable insight into aspects of your company that can impact your figures, whether negatively or positively.

In your forecast, allow flexibility for any one-off payments that might come up down the road. These figures can include:

• Purchases of business equipment
• Training for new employees
• Annual bonuses
• Loan setup fees.

If you’re unsure if any of these expenses might show up, it’s better to use your business savvy and include them as a safety precaution. This aspect of your cash flow forecast can also include surprise inflows of cash you weren’t expecting. A detailed estimation of your incoming cash flow might consist of:

• Rebates and refunds
• Additional capital from partners
• Approved grants
• Loans you’ve given being paid back
• Sale of an asset
• Royalties
• Other miscellaneous fees.

Once you prepare all the necessary data and decide on the time frame for your forecast, you need your beginning bank account balance for that period. This amount is also known as “cash on hand”. Next, add all the projected inflows of capital and subtract the projected outflows. If you have a positive number, great. If not, you might have to readjust your planning for that period.

At the end of the period you’ve forecasted, review your estimate against your actual cash flow. If anything in your forecast didn’t measure up, this gives you a vibrantly clear picture as to why.

3. Create scenarios

When you’re forecasting your future cash flows, imagining different scenarios can be incredibly helpful.

Say you’re the owner of a timber mill and there’s a wildfire in the forests surrounding your area. That not only means you can’t cut any more wood until the fires have been put out but, depending on your local zoning and proximity to the fire, you may not even be able to operate your mill. If your business operates in an area prone to natural disasters such as fire then forecasting a cash flow model that includes unforeseen circumstances can help you avoid a reactive scramble later down the line.

4. Gather the right input from the right people

Asking for advice from other small businesses like yours is one of the best ways to discern what changes need to be made to your current cash flow forecasting model. Sometimes, what you’re already doing requires a bit of adjustment to ensure your forecast numbers are as accurate as possible. Some of the aspects of your current forecasting methods may be returning incorrect figures concerning:

• The amount of data
• Fluctuations in payables and receivables
• Slow pay-offs
• An unusually high amount of inventory

Not enough data

Like many small business owners, your time is probably split half-and-half between ensuring your customers are happy and making sure your staff is on the ball. Juggling these two aspects of your business continually means you might let your financial management fall to the wayside. But the only way you’re going to have accurate outcomes in your cash flow forecasts is by keeping track of your historical financial data. What happens to your business in the summer? Does your business fluctuate with the seasons?

What happens around the festive season? Do you have a track record of purchasing too much inventory in the hopes of fantastic sales, only to have much of that stock remaining long after the festive season has passed? If you don’t keep track of this historical information, projecting anything for the future can be difficult. Even just one year of data can suffice in most cases.

Fluctuations in payables and receivables

If you base your forecasting on the average number of days it usually takes for each client to pay you, what happens if that client suddenly begins paying later than usual? It can wreak havoc on your figures. If you have large accounts that you count on for much of your cash flow, it’s essential to monitor these clients more often than others.

The same can be said in reverse. What if you usually pay your suppliers every 15 days, but you decide to let a couple slide for just a bit? This can have an impact on your outflows and temporarily (and aesthetically) boost your numbers.

If you end up having an unforeseen expense before paying these suppliers, it can mess with your bottom line.

Small business payroll

Another aspect of these types of fluctuations can occur within your . For instance, labour expenses during the holiday months may be higher than usual, with employees working longer hours to accommodate Christmas shoppers. Just one or two team members going into overtime can mean a higher output of cash come payday. Using an out the year.

Slow return on investment

There are many ways you can invest in your company, from purchasing new equipment to hiring new employees. The idea is that after a certain period, this investment pays for itself and then begins to earn more money for the company. Sometimes it doesn’t work that way. New investments are sometimes very slow to generate returns, and some don’t ever entirely pay off the way you expected. Be wary when including these types of figures in your cash flow forecasts.

An unusually high amount of inventory

This can happen for a variety of reasons, not the least of which is an overabundant purchase just before the festive season in hopes of making a killing. If these products don’t sell, though, you’re left with stock that could drain your cash flow. Reviewing your inventory trends throughout the year can help you better analyse the amount you need at any given time of the year. While it’s better to have too much rather than not enough, finding a happy medium can help your business thrive.

5. Monitor, adapt and pivot: direct and indirect cash flow forecasting

Direct cash flow forecasting

This method of cash flow forecasting lets you manage your liquidity in the short term. This method aims to illustrate how your cash moves into and out of your company at specified future dates. To run this forecast, you typically enter payments and receivables as occurring on a specific day, or during a particular week or month. Then the figures are combined to cover the length of time for which you’re running your cash flow forecast. For this method to be useful, your time frame should be 90 days or less, though some companies can successfully project as far out as one year.

Indirect cash flow forecasting

The indirect method is used when you create your budget as part of your planning stage. You use figures from income statements, balance sheets and other essential accounting documents to project your future cash flows. There are three different ways you can use indirect cash flow forecasting:

• Adjusted net income (ANI): calculates your projected cash flows from operating income figures with balance sheet changes and accounts payable and receivable factored in.
• Balance sheet (PBS): use the ending data from a predicted balance sheet to calculate your cash balance for a future date; if all other accounts have been appropriately projected, your cash account will be, as well.
• Reversed accrual method (RAM): a hybrid of the above two methods that uses statistics to calculate the figures from both, reversing substantial accruals, thereby calculating how your cash flows in one specific period.