Cash flow is simply the money that flows into and out of a business. Remember, cash and profit are not the same; you can have a profitable business that is short of cash. In extreme cases, you can have a profitable business that goes bust for lack of cash. That’s why understanding, monitoring and protecting cash flow is so important.
Negative Versus Positive Cash Flow
If you pay your bills on time but let customers take longer than agreed to pay you, money will flow out of the business faster than it flows in and you could have a negative cash flow.
On the other hand, if you take payment at point of sale or in advance but pay your creditors in arrears, you will likely have a positive cash flow.
Cash Flow Forecasting
Cash flow forecasting – projecting the movement of cash within the business – is enormously beneficial when it comes to getting a handle on what funds will be available to you in future weeks, months and even years. Let’s look at three key benefits of accurate cash flow forecasting.
1) Spotlights Shortfalls
In business, things can happen unexpectedly; expenses can crop up and usually reliable customers might pay late. We can’t anticipate every eventuality.
We can, however, determine whether we can handle expected expenditure over a period of time. Cash flow forecasting shows us where we have a potential shortage of cash and allows us to take corrective action before the business is adversely affected.
2) Facilitates Strategic Decision-Making
Making plans is exciting, and necessary, but we need to make sure we can fund our projects. Whether you’re acquiring new premises, hiring more team members, or purchasing new software, tools or equipment, you need to be confident the business can meet the costs.
Cash flow forecasting might indicate, for example, that plans need to be scaled back at the current time. Equally, it might show you can scale up if you wish.
Whatever you are planning, the clarity cash flow forecasting brings to your understanding of the business’s financial position enables you to make informed and confident decisions.
3) Establishes Credibility
If you are sharing information with third parties, whether they be stakeholders or suppliers, potential lenders or investors, the inclusion of robust cash flow forecasts that demonstrate the financial stability of the business will help establish credibility.
They indicate that the business is fully understood and well managed. They add authority to your plans and offer reassurance that you will achieve your goals.
Five Steps to Take to Draw up a Cash Flow Forecast
| 1) | Pull Together Historical Financial Data | You will have financial data to use as a foundation, such as balance sheets, management accounts, income statements, profit and loss and so on. Gather together what you have available. |
| 2) | List Sources of Income | This might include fees, sales, loans or investments. List them, showing what you expect to receive, when, and how much. Flag repeating payments, such as monthly subscriptions to services. When estimating income, be realistic. |
| 3) | List Expenses | Make a list of outgoings, split between fixed and variable. Fixed will include things like rent and rates. Variable will include things like raw materials and team member costs. Again, be realistic. |
| 4) | Consider Seasonal Trends | Many (not all) businesses are affected by seasonal fluctuations. Your forecast needs to take into account those periods where things are busier and also where they slow down. Your fixed costs, of course, will not change. |
| 5) | Allow Something for Contingencies | As mentioned above, we can’t anticipate everything – but we can assume there will be unexpected events that we have to deal with. As well as being adverse, such as a customer going bust, an unexpected event could be positive, such as a customer growing and needing more from you. In your cash flow forecast you generally need to focus on potential adverse events and build in a buffer to protect you against harm. Should something positive happen, that’s a bonus. |
What to Do Next
A cash flow forecast isn’t something you do then put in a drawer; it’s a dynamic document. It needs to be regularly updated, taking into account changes in the actual movement of money through the business. Experience will allow you to refine your forecasts.
GreenStones provide a Forecasts and Budgets service, for more details about how we can support you with your cash flow forecasts, give the team a call on 01733 371180.