The Value of Cash Flow Forecasting

close up of someone counting money into a cash drawer

A cash flow forecast is an estimate of the amount of money you expect to flow in and out of your business, including all your projected income and expenses, usually covering the upcoming 12 month time span.

Understanding cash flow is the key to running a successful small business. Smart cash flow management will help ensure your business runs smoothly, as it gives you the insight to keep on top of your business’s financial health.

Making better decisions with a cash flow forecast

A cash flow forecast can help you make better decisions. For example, it can allow you to:

  • Predict and deal with upcoming cash surpluses or shortages.
  • Plan how to meet tax obligations.
  • Time new equipment purchases.
  • Identify if you need a small business loan or a new line of credit.

Cash flow forecasts can also help you judge the effect of an upcoming business change or decision. For example, if you’re considering hiring a new employee, you can add the additional salary and related costs into your forecast. The new figures in your cash flow forecast can tell you whether hiring that additional employee is likely to strengthen your business.

Including the best, worst and most-likely scenarios allows you to judge how your business will fare if you suddenly hit tough times or encounter trading conditions that are better than you expected.

Check your business’s performance

You can use your cash flow forecast to check if the business is meeting your expectations by:

  • Comparing actual income and expenses with your forecasts to identify areas where your business is performing above or below expectations.
  • Reviewing your actual performance against your forecasts to discover any variances that might require further investigation.

For example, if your sales are higher or lower than forecasted, you’ll want to find out why. Ask yourself:

  • Were your forecasts too high or too low?
  • Has an existing competitor changed its strategy or has a new competitor entered your market?
  • Do you have a customer service or quality control issue?

Using forecasts in this way allows you to actively manage your business, as it empowers you to ask the right questions and make better decisions.

How to complete a cash flow forecast

To begin drawing up a cash flow forecast for your business, follow the steps outlined below. You can also use our cash flow forecast template to guide you through the process.

Estimate your sales

Start by estimating your likely sales for each week or month of the next year:

  • Use sales figures from the last couple of years to predict the sales you can expect.
  • Adjust for seasonal patterns and one-off events, such as trade shows.
  • Factor in your future marketing plans.
  • Consider current market conditions and trends.

If you’re starting a business, base your sales estimates on:

  • Hard evidence of market demands, such as advanced sales or orders gained, contracts signed or test marketing on a limited scale.
  • Information from customer research and surveys.
  • Research into the performance of similar businesses.
  • Information from suppliers and industry experts.

If you’re planning a new marketing drive or launching an exciting new product, you’ll need to put these increased sales expectations into your sales forecasts.

Similarly, if a new competitor has just entered the market, you might want to drop your forecast figures a little to allow for the impact they could make on your market share.

Forecast the timing of cash

Forecasting is easy if you operate a cash-only business because payments occur at the time of sale. If you sell on credit, you’ll need to factor in likely delays in payments. If your terms are 30 days, you can expect to receive payments between one to two months after a sale has been made.

Estimating payment timing is a skill that improves with practice. Some payments may arrive sooner, some later, depending on how effectively you manage credit sales and debt collection.

Now that you know how much income you can expect (and when to expect it) you can put these figures into the correct columns in your cash flow forecast.

Estimating fixed and variable costs

Cost totals are made up of fixed and variable costs. Fixed costs (overheads) are those you’ll have to pay regardless of your level of sales, such as rent, salaries and utilities.

Variable costs change with your sales levels. For example, if you sell more products, you’ll need to order more raw materials or inventory. Make sure you:

  • Use your forecasted sales levels to work out the amount of inventory or raw materials you’ll need to buy to meet your orders.
  • Identify other bills you’ll have to pay and when you’ll have to pay them.
  • Go through your historical payment records to check that you have included annual bills or expenses, like accounting fees or taxes that don’t occur every month.

Once you’ve identified all of your expenses and when you need to pay them, add them to your cash flow forecast.

Start using your forecast

Your forecast is ready for use once you have entered your weekly or monthly income and expenses. Simply add in an opening bank account balance and the cash flow forecast template will automatically calculate the bottom line cash position for each weekly or monthly period.

You can see if you have enough money to pay bills each month or if your business needs more working capital. If you spot a cash flow crunch in a future month, you have time to approach lenders and investors about financing options. You can also plan what to do with any cash surpluses.

Update your estimates against actual business performance (on a weekly or monthly basis) so that your cash flow forecast is as accurate as possible. Accurate information is essential to the decision-making process. 

This information is provided for general awareness purposes only and is not intended to be relied upon as legal or compliance advice.

This article is provided for informational purposes only. While the information contained within has been compiled from source[s] which are believed to be reliable and accurate, Comerica Bank does not guarantee its accuracy. Consequently, it should not be considered a comprehensive statement on any matter nor be relied upon as such.

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