Understanding the benefits of a cash flow forecast will encourage you to use this important tool
Stephanie Moore
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Monitoring your cash flow can be the difference between success and failure. Get it right now because as you grow you'll understand the benefits. Danny explains more. Viewing time: 5 minutes; 25 seconds Reading time: 4 minutes; 31 seconds
A cash flow forecast is a tool that allows you to predict the net cash flows of the business over a future period. The forecast estimates the cash coming into your bank account and what your expenses are likely to be. The cash flow forecast results in an estimate of the bank balance at the end of each month.
A business uses a cash flow forecast to:
Identify potential shortfalls in cash balances – for example, if the forecast shows a negative cash balance, then the business needs to ensure it has a sufficient bank overdraft facility
See whether the business's trading performance (revenues, costs and profits) turns into cash.
Analyse whether the business is achieving the financial objectives set out in the business plan (which will almost certainly include some cash flow budget)
Why cash in business is king?
Managing cash flow in your business is critical. Revenue, profit and costs are all equally important, but your cash management, in terms of your daily, weekly and monthly trading, keeps your business afloat. The simple fact is that nearly every business is a creditor and a debtor since businesses extend credit to their customers and pay their suppliers on delayed payment terms.
Cash can stifle your business's growth potential, and proactively managing the ratio between these two levers is critical to fund your growth ambitions.
A word of caution about your cash management
Though it sounds mad, companies often get muddled up about the amount of money they have on hand at any one time because, usually, they're simply holding it for someone else.
For example, the revenue you collect on behalf of the Government in the form of corporation tax and VAT. Those amounts come into your account on payment of every invoice, but it's critical that you ring-fence them, perhaps by putting them into an entirely separate account, because they are something other than yours to spend.
Often, companies receive a corporation tax or VAT bill – which is predictable and happens regularly. This should come as no surprise. Corporation tax, VAT – or your equivalent – is not operating capital, and if you find yourself using it as such, your business model simply isn't working. Revisit the fundamentals of your business growth model. So, cash is king in business. Track its whereabouts. Negotiate favourable terms and don't spend what's not yours.
How good are you at managing cash flow in your business?
If a business runs out of cash and cannot obtain new finance, it will become insolvent. Therefore, it is no excuse for management to claim that they didn't see a cash flow crisis coming.
In business, cash is king, particularly in start-ups and small enterprises. As a result, it is essential that management forecast (predict) what will happen to cash flow to make sure the business has enough to survive.
Here are the key reasons why a cash flow forecast is so important:
Identifies potential shortfalls in cash balances in advance – think of the cash flow forecast as an "early warning system". This is the most important reason for a cash flow forecast
It ensures the business can afford to pay suppliers and employees. Suppliers who don't get paid will soon stop supplying the business; it is even worse if employees are not paid on time
Spot problems with customer payments – preparing the forecast encourages the business to see how quickly customers are paying their debts. Note – This is not a problem for businesses (like retailers) that take most of their sales in cash/credit cards at the point of sale
As an essential discipline of financial planning – the cash flow forecast is a necessary management process, similar to preparing business budgets
·External stakeholders such as banks may require a regular forecast. Indeed, if the business has a bank loan, the bank will want to look at cash flow forecasts at regular intervals
Top tips for avoiding a cashflow crisis
Your cash management keeps your business afloat; fundamentally, it's about one measure that matters—your debtor-to-creditor ratio. Many small business owners don't know their creditor numbers and, even more surprisingly, their debtor numbers. You are not there to provide an accessible credit facility for your customers; you're not a bank. Don't let your debtors treat you like one.
It will cripple your growth potential and lead you to sleepless nights because you can't pay your employees and bills. However, it doesn't have to be this way if you are proactive in your debtor management, and the great news is that this is not complicated to fix. First, you should be creative in positioning your compelling value proposition and the associated payment terms, and second, you should negotiate practical terms, especially if cash is tight.
take action; achieve more
Data from your cash flow analysis can provide valuable insights into your business; as you expand, it becomes more and more critical to your growth and success
Please don't create the information and then leave it to gather dust. Get your people around the table weekly or monthly to review
This intelligence works hand-in-hand with your management accounts. Collate the information and develop a strategy to aid your development - it becomes fun when you look back over time and gives you confidence in future investments
