How to Forecast Cash Flow

1. Introduction
2. Example of a cash flow forecast
3. Listing the receipts
4. Listing the payments
5. Preparing the forecast
6. Using the forecast
7. Hints and tips
   
   < Back to Cash Flows

1. Introduction
A cash flow forecast is a prediction of when cash will be received by your business and when it will leave. You can then be forewarned of any shortfall and make arrangements to reduce spending, to borrow money or to inject capital when necessary.

For start up businesses, it is essential to know exactly how much finance you will need to take the business through its early stages, and to pinpoint when you will need it. The forecast is a key part of any business plan from the point of view of potential funders.

2. Example of a cash flow forecast
A typical forecast is split into three sections:

• receipts (all money coming into the business, e.g. from sales, loans)
• payments (all money leaving the business to cover expenditure, repay loans, etc)
• balances (monthly balances and the cumulative balance)

The cash flow forecast only shows cash moving in and out of your bank account, so it ignores non-cash items such as depreciation (the loss in value of assets through wear and tear or the passing of time). Note that 'receipts' and 'payments' are not the same as 'income' and 'expenditure'. When you invoice a sale, it can be recorded immediately in the profit and loss account. But until the cash is received, there is a corresponding entry of 'debtor' on the balance sheet. The cash flow shows when you expect to actually receive the cash. Similarly, if you buy raw materials on credit, you will charge materials to the profit and loss account immediately - with a corresponding 'creditor' entry on the balance sheet. The cash flow shows you when you expect to pay out the cash for those materials. To be able to prepare a forecast, you will first need to prepare budgets for the year ahead, e.g. to assess how much the business needs to spend on the various categories of expenditure. Ideally, you should prepare a monthly profit and loss account (and possibly a balance sheet too) at the same time as the cash flow forecast - preferably all on a computerised spreadsheet.

Click here for a Cash Flow Forecast Template

3. Listing the receipts

• Sales
  Sales will be shown as a row on the profit and loss account. Show sales by value, i.e. selling price multiplied by number of sales; forecast these for the next year as accurately as possible. To complete the cash flow forecast, you need to estimate the length of time it will take to collect money from customers (typically at least 30 days from issuing an invoice). So the receipts would be shown on the cash flow in the month following their sale as recorded on the profit and loss account. It will help with the calculation if you show VAT separately.
• Other receipts

Show any grants, loans or savings which will be put into the business.

4. Listing the payments
Payments include general business costs as well as capital purchases and other charges. As with receipts, this can be linked to the profit and loss account. Items for which you do not pay immediately will need an appropriate delay (say, a month).

• Costs will include fixed costs for the business over a length of time (e.g. rent and salaries) and variable costs, which are related to production levels (e.g. cost of raw materials to manufacture the product).
• Taxation: If the business is registered for VAT, you should show input VAT (with receipts), output VAT (with payments) and the balance being paid (quarterly or annually) to Customs & Excise. If the business is operated as a limited company and pays corporation tax on chargeable profits, this should also be included.
• Professional fees for regular accounting or auditing, and possibly for legal advice.
• Capital purchases of large equipment, i.e. items that you expect to last more than 12 months. Estimate when you will make these purchases and how much they will cost, including hire purchase and leasing payments. Not all the costs listed will apply to every business, and your business may have costs that are not mentioned here. List all the items that apply to your business.

5. Preparing the forecast
As shown, the cash flow forecast is set out as a table, with receipts and payments placed in the months in which they occur. If the business is not yet trading, show the figures from the month in which the business is going to start trading. When you fill in the figures, it will be useful to do it in the following order:

• Complete the predictable payments first. This will be simple for those made monthly; for others, e.g. advertising costs, predict when they will occur.
• Then estimate what your sales receipts will be, remembering to allow for seasonal variations, if these affect your business.
• Once you have compiled a sales forecast, you can fill in the variables, which depend on levels of sales and production.
• List all items separately, in the month in which your business will receive (or spend) the money.
• Round-up all figures to the nearest pound before entering them to avoid over-complicating the financial picture.

6. Using the forecast
Once you have completed the forecast entries as far as possible, calculate the total receipts and payments for each month. Subtract the total monthly receipts from the total monthly payments and you will forecast a monthly balance of money in the bank. Enter the forecast bank balance from the end of each month as the opening balance for the next month. At the start of a business, the opening balance will be nil. Now you can use the forecast to determine:

• How much cash the business needs to meet its costs
• When an injection of cash is needed
• How much personal income (drawings) the owners can allow themselves from the business.

7. Hints and tips

• Remember to allow adequately for the lag between invoicing a sale and actually getting the payment into your account. Small businesses often struggle because they must meet their production costs before they receive payment, and do not have enough working capital in the bank to survive comfortably during this waiting period.
• Be cautious, especially at start up, about how much cash inflow you anticipate. In the early stages, cash tends to go out from the business more quickly than it comes in.
• Do a three-year forecast if you are looking for outside investment. Show the first year cash flow monthly, the second year quarterly and the third year as a single figure.