How to prepare and use a cash flow forecast in 6 easy steps

How to prepare and use a cash flow forecast in 6 easy steps

How to prepare and use a cash flow forecast in 6 easy steps 

Cash flow forecasts are essential to all businesses to make sure that they don’t run out of cash and become insolvent. Insolvency is when a business can’t pay its debts when they are due and it is one of the most common reasons why businesses (large and small) fail. 

To prepare a cash flow forecast, you need to understand your business and your cash flow cycle. There are five steps to prepare a cash flow forecast, the sixth step is to make sure that you use it effectively: 

1. Decide what time period to do your forecast

Depending on the nature of your business you may need to prepare sales forecasts over different time periods. For SMEs a typical forecast may be by month over 3, 6 or 12 months. More detailed forecasts for shorter periods e.g. when cash flow becomes a critical issue, may be required on a weekly or even daily basis. 

2. List all sources of money coming into your business

  • Income Start with what income is due to you i.e. what you have already sold but customers have not yet paid for, and then what you expect to come in over the next period(s). Forecasting sales can be tricky but there are various methods that you can use e.g. a percentage of leads will convert to sales or base your forecast on last year’s sales multiplied by a factor based on whether your sales are on average increasing year-on-year or falling year-on-year. To do this well, you should review your historical sales data, use your sector-specific knowledge and experience (sometimes called ‘gut instinct’) and consider what impact the current economic climate may have on your sales. It may seem impossible to do when there are so many unknown factors, but the more you do it, the more prepared you will be to make informed business decisions more quickly. 
  • Funding e.g. grants, loans and investments 
  • Sales of assets e.g. property, equipment, vehicles 
  • Other income e.g. bank interest and tax rebates 

3. List all your outgoings

Make sure you know what money you owe people such as your suppliers and HMRC, and when you need to pay that by. Then list what money you know and anticipate needing to spend over the coming period(s). It is useful to identify what expenses are fixed and essential to running your business, what costs are discretionary (and therefore could be reduced or cut if need be) and what costs are directly related to sales. This will enable you to work out your variable costs as sales increase/decrease. 

4. Work out your cash flow

There are various tools and software programmes that will integrate with your accountancy software, but often a simple spreadsheet is the best starting point to capture your income and outgoings over time. There is a free template in Microsoft Excel – projected cash balances below the minimum amount you specify are displayed in red and you can also see a chart of your projected monthly balances. If you would like help to build your own cash flow forecast, then our team is here to help. 

5. Make a note of your assumptions and review them regularly

It is important to review your assumptions by actively reviewing variances in actual and forecasted values. This will help you to improve the accuracy of your assumptions and forecasts. 

6. Update your cash flow forecast regularly and follow our top tips for effective cash flow management

The frequency that you update your cash flow forecast will depend on the nature of your business and how often the factors that affect your cash flow are likely to change. Key variables include how quickly your customers pay you, what working capital you need and what you plan to invest in. All these factors and more will affect your cash flow. Learn how to manage your cash flow effectively by reading our article on effective cash flow management, and use our cash flow checklist to help you stay on top of the process.

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Tanya Bennett, Chartered Accountant (ACA)

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