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Preparing a cash flow forecast

Why create a cash flow forecast?

A cash flow forecast will show you and your management team what your cash position is likely to be over the coming months.

It can be created in a variety of ways – for example, using a traditional computer spreadsheet, an app, or online accounting system but no matter how you do it, it does not need to be complicated.

Depending on the maturity and complexity of your business, sometimes a simple diary or Excel spreadsheet can give you the insights you need but what’s more important than the system you are using, is the information you put into it.

Top tip: Start simple. Look at what revenue you are forecasting over the next 3 months and what the overheads and cost of sales are likely to be. It’s more important to have a system in place, however imperfect, than to ignore potential problems that may lie ahead.

In times of uncertainty, as we’re currently facing in relation to COVID-19 (Coronavirus) and EU Exit, it’s more important than ever that business owners and management teams are able to accurately predict their cash position over the months ahead.

In this short guide, we’ll list out some of the most important factors to consider, the assumptions you may need to make and further considerations to help you refine your cash flow forecast as your business matures.

Your business advisor, accountant or corporate finance advisor will be able to assist if you need help in preparing a detailed financial model or cash flow forecast. Typically, they will need you to have thought about the following:

Inputs are key to the usefulness of your cash flow forecast:

  • What is the forecast turnover by month (or maybe weekly or daily for a retail business)?
  • What is the cost of sales forecast – raw materials, labour and other costs?
  • How long do you take on average to pay suppliers?
  • How long do customers take to pay invoices on average?
  • How much stock or inventory needs to be held?
  • When is rent due?
  • How much money (capital expenditure) is spent monthly on acquiring or maintaining fixed assets such as land, buildings, machinery and other equipment?
  • How much will you spend on Research and Development (R&D), PAYE/NI, VAT, and loan repayments?

Top tip: revisit these inputs and assumptions on a regular basis and review them closely when a business is going through change.

How to create a cash flow forecast

Your cash flow forecast starts with known facts. This is typically last year’s data, plus or minus a percentage based on your predictions for the year, growth plans, uncertainty in the market and other assumptions you will make based on the knowledge that, as a business owner, you have in your head.

There are 7 steps to the process:

  1. Start with assumptions
  2. Add sales income / revenue
  3. Add any other income streams
  4. Subtract expenses
  5. Subtract any other cash outgoings
  6. Pull together your cash flow forecast
  7. Create different scenarios

STEP 1. Start with assumptions

Assumptions drive cash flow forecasts. To be useful as a management tool, the forecast’s underlying assumptions must be appropriate – based on past performance, industry publications and discussions with customers and suppliers.

Assumptions should be made with the input of relevant people on your team. Things to consider include:

  • The impact of any price increases on sales and timing
  • The impact of any cost increases on purchases and timing
  • Estimates of any changes in sales volume
  • The impact of seasonality
  • Any other general cost increases and the timing of them
  • Salary and wage increase and the timing of them

Preparing a clear list of these assumptions can explain variations when actual performance is reviewed against the forecast. When preparing the forecast, it’s vital that assumptions which are then used as variables in the forecast are clearly set out and not interconnected or hard programmed into the forecast.

STEP 2. Add sales income

The starting point for a sales forecast is the previous year’s sales data. With these facts, and using sales price increases and demand changes, you can predict future revenue.

Once future sales are arrived at, for the purpose of the cash flow forecast, the timing of when cash is received from customers should be overlaid.

There will be a historic pattern to customer payments – a certain percentage will be within terms and the remainder will sit outside terms to different extents. This historic pattern of customer payments should be one of the underlying assumptions.

Top tip: if your customers consistently pay you late, you are not alone. One third of payments to UK SMEs are late (source: Small Business Commissioner) Read our three steps to tackling late payment 

STEP 3. Add ‘other’ cash inflows

There will be other anticipated cash inflows (money coming into the business), which will be different for each business but should be listed. Examples include:

  • tax refunds
  • VAT
  • insurance claim proceeds
  • sale of any fixed assets or property
  • government grant income
  • any royalties or income from franchisees
  • any further equity investment or new loans

STEP 4. Subtract expenses

All direct and indirect expenses (otherwise known as “cash outflows”) required to operate the business should be identified and the timing of payment considered for the cash flow forecast. This includes:

  • payments to suppliers for raw materials or products for sale
  • software and other licences used in production
  • staff wages and salaries
  • marketing and distribution costs
  • payment for fixed assets and maintenance costs
  • loan repayment

STEP 5. Subtract other cash outflows

There are other cash outflows which should be incorporated into the cash flow with careful consideration given to timing. These include:

  • corporation tax
  • payment of employees’ income taxation
  • VAT
  • legal expenses
  • insurance premiums
  • any dividends paid out, for instance

STEP 6. Pull your cash forecast together

A cash forecast is a prediction of the business’s future cash position, looking forward at what your bank account (or accounts) will look like on any given future date.

  • Start with your “opening cash position” – the amount of money in your business bank account or accounts, and on credit cards and other borrowing, at a point in time
  • Add in predicted cash inflows and deduct cash outflows, showing the dates when these will happen
  • Look at how much cash you are predicting will be in the business on a monthly, weekly or even daily basis (the frequency will depend on the nature of the business and the level of incomings and outgoings)
  • This will show you the predicted “closing cash position” on any given date
  • You can use this information to predict any potential cash shortfalls, and to plan accordingly

Top tip: The best way to pull this together, is simply to make a start. For a simple cash flow forecast, you can start with a blank piece of paper or Excel spreadsheet.

Check whether your accountancy system has inbuilt forecasting tools or ask your accountant or bookkeeper whether they have a template or app they can recommend, or if they can assist you.

STEP 7. Scenario planning

To make the cash flow forecasting process as informative as possible, running ‘what-if’ scenarios on the completed forecast will help determine how much capacity a business has to withstand unforeseen events, such as:

  • loss or default of a major customer
  • acquisition of a new customer, but with extended payment terms
  • loss of a supplier or increased cost from a new one
  • the need to replace equipment ahead of schedule
  • stock obsolescence (i.e. when the items you are storing are no longer saleable – perhaps they are out-of-date, out-of-fashion or there is simply no longer a market for them)

Top tip: It’s important to ensure that your model or forecast can be easily adjusted to reflect a variety of scenarios. Create your most likely scenario, then add 10% to the cost of raw materials, or account for the loss of a major customer, so that you understand what level of variance the business can cope with.

Cash position in relation to assets

By looking at the relationship between the assets held by a business (e.g. stock, property, equipment, etc.) and cash, you can generate a financial ratio that measures how well your business can generate cash from your current operations.

You (and/or your accountant) can calculate cash flow to assets by subtracting net cash flows from operating activities and dividing the resulting number by average total assets.

This provides a headline figure to help you make the right decisions for the business at every stage along the journey. Detailed monitoring of cash performance versus forecast serves two purposes:

  1. It enables management to keep its forecast assumptions up to date.
  2. It helps management focus in on areas where corrective action may be taken to improve cash flow. For example, is too much stock of a particular product being held? Or is too much stock being held at a particular location?

Top tip: ask your bookkeeper or accountant to help monitor your cash position in relations to assets

"In terms of guidance regarding COVID:19, we urge businesses to contact their finance providers early to discuss how they can support themselves and their clients and customers through the coming weeks.”

Stephen Jones, Chief Executive, UK Finance

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