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The basics of cash-flow forecasting

A readily available and regularly updated snapshot of the money coming into and out of your business can be the difference between success and failure.

Last updated: 12 Nov 2019 5 min read

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Research suggests that cash-flow issues are behind up to 90% of small business failures. “Cash is what makes and breaks a business,” says business adviser Chris Chapman, founder of SME finance consultancy Numitas. “You can be making profit on paper, but having cash in the bank is a very different thing. If you don’t understand what your cash position is, it can be easy to run out of it – and to be out of business.”

A cash-flow forecast is a projection of the cash coming in and the cash going out of your business over a specified period of time. It allows you to estimate all the money you will receive – “whether that’s from customers, grant income, or R&D tax credits”, says Chapman – and also what you’ll spend, including overheads, staff salaries and material costs.

Every business will have periods of positive and negative cash flows. This is quite normal, says Graham Dotchin, corporate finance associate at Tait Walker, a large independent accountancy practice in the North East. “How you manage these peaks and troughs will determine how successful your business is and how staff, customers, suppliers and investors will view your business,” he says.

Why is cash-flow forecasting helpful?

Good forecasting lets you anticipate difficult periods and prepare for them, thus averting many businesses’ worst nightmare: running out of money. If you can see that there will be a hole – for whatever reason – in two months’ time, you can plan for it.

For Jo Fleming, founder of Yorkshire Staffing Services, cash-flow forecasting became a priority quite soon after founding. She had to pay the people that her recruitment business placed every week, while she in turn was only being reimbursed by the companies they work for every 30 days.

“We were OK until we won a couple of big accounts and they wanted longer payment terms,” says Fleming. “We really quickly had to go to the bank and ask for an invoice factoring facility, which allowed us to borrow up to 80% of our sales ledger. If we hadn’t been able to do that, we’d have been looking at a cash-flow shortfall of around £200,000.”

“There’s a massive difference between what sales you’re going to close and when you’re going to get the cash from those sales. That’s the biggest downfall of most small businesses”Chris Chapman, business adviser, Numitas

The downside of factoring is that it comes with a fee, meaning it costs the business owner money. Fleming says that the episode forced her to be far more diligent about cash-flow forecasting, and also made her negotiate harder for speedier payment terms when starting business with new clients.

“Finding the time to set up a good forecasting system is really important,” says Nelson Phillips, a professor at Imperial College London Business School, “because once you’re facing cash-flow problems you’re always going to be giving something up to get that money in the bank right away.” Overdraft fees, loan interest and discounts are just three examples.

How to prepare a cash-flow forecast

It’s a straightforward process, says Chapman, and can quickly be set up on a spreadsheet. Dotchin says: “A simple way to start is to pick a period in time, for example the end of the month. Add your current cash balance to how much cash you will receive, then subtract how much you need to spend.” The latter figure should include everything from payments to suppliers to non-creditor payments such as staff and HMRC and any investments you need to make – new equipment, for example.

The closing cash balance will indicate how you will end the month if your assumptions are correct. “Understanding the components of cash flow gives you the ability to make strategies to help improve the overall picture and/or seek additional finance if you don’t have enough to cover your short-term negative cash flow,” Dotchin says.

What can go wrong?

“The only thing you know for certain about your cash-flow forecast is that it will be wrong – you just hope it’s not wrong by too much,” says Colin Garvie, assistant professor of accounting and finance at Edinburgh Business School. “People always underestimate the amount of money they need and when they need it. They do their cash-flow forecast, and then three months in they find they’re not being paid fast enough and they’re having to pay their supplier much faster than they thought.”

A commitment to being realistic, then, is vital for a cash-flow forecast to have any value. “There’s a massive difference between what sales you’re going to close and when you’re going to get the cash from those sales,” says Chapman, “and that’s the thing that’s the biggest downfall of most small businesses when they do cash-flow forecasting.”

Why you can’t live without one

New businesses that are bursting with pride at the speed at which orders are coming in need cash-flow forecasting more than anyone, as they may find that customers change their mind; they can run up against unexpected costs; and inevitably there’s a lag between making a sale and actually getting paid for it. In fact, says Chapman, the smaller the business, the tighter you have to keep a handle on your cash. Forecasting can – and probably should – be done on a weekly basis.

“Remember that a plan is just a plan,” he says. “Your aim is to understand any changes and remodel your assumptions going forwards, so that your forecast becomes a rolling forecast that’s constantly updated by the knowledge you have gained.”

For Yorkshire-based online office supplier Office Monster, diligent cash-flow forecasting has helped steer them to rapid growth within just three years of launching. “By mapping it all out,” says director Steve Hanley, “we’ve been able to make informed decisions that support the sustainability of the business as we move forward. Cash-flow forecasting today can definitely take the headache out of tomorrow.”

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Leadership and Management, Strategy and Planning