Forecasting cash flow can help you make important investment decisions or warn you of trouble ahead. Here's what you need to know about cash flow forecasts.
What is a cash flow forecast?
A cash flow forecast is a simple document or spreadsheet that provides an estimate of the money flowing into and out of your business during a certain time period – often 12 months. It includes predicted income and expenses, and provides an at-a-glance assessment of future cash flow. This can be a great help when planning major business decisions.
Business owners and managers have plenty to occupy them in terms of the day-to-day running of their businesses. Looking further ahead than a few weeks might seem impossible or even unnecessary. However, forward planning is vital to the health of any business. Everyday business decisions are tactical; long-term decisions are strategic. To succeed, a business needs good tactics and a good strategy.
The purpose of a cash flow forecast is to improve business strategy by providing a prediction of future cash flow. Since cash flow is one of the clearest indicators of the health of a business, the importance of cash flow forecasting is evident.
Advantages of cash flow forecasts
The biggest advantage is clarity. A cash flow forecast gives you a glimpse into the future, a look at the possible state of your business. Armed with that knowledge, you can make important decisions now.
For example, if the forecast shows that you're likely to have a significant excess of free cash in the business, you might start planning to invest in more staff, bigger premises or a wider range of stock. On the other hand, if the forecast indicates a significant tightening of cash flow, you can make some changes now to minimise its impact. You might postpone expansion plans, for example, or cut costs and launch a new sales drive to increase income.
With a cash flow forecast, you can apply for loans or other sources of funding to help your business expand. It's one of the most important documents that any lender or investor will require before making their funding decision. It gives them a clear picture of the probable future of your business.
By adjusting the numbers, cash flow forecasts also allow you to determine how your business might perform under a range of different conditions – boom time or recession, for example. This knowledge can give you peace of mind that you can handle any eventuality.
Disadvantages of cash flow forecasts
There are hardly any disadvantages to cash flow forecasts, but it is important to remember that it is only a projection. It can't predict the future of your business with absolute certainty. Nothing can do that.
Just as a weather forecast becomes less accurate the further ahead it predicts, the same is true for cash flow forecasts. A lot can change, even in 12 months. Even if your forecast about your own business is accurate, the wider economy can affect the outcome in the real world.
How to forecast cash flow for your business
There are three main components to a cash flow forecast. All three are required in order to generate an accurate representation of your business now and in the future. Note that for some cash flow forecasts, these three categories are broken down into subsections for more detail and accuracy.
Estimated sales: The first thing you'll need is an estimate of your sales for the forecast period. This can be obtained by looking at past sales figures over similar periods and extrapolating. Be sure to take into account seasonal variations and the impact of the wider economy on your particular area of business. Be realistic here – don't assume that previous growth trends will necessarily continue unchecked.
Payment timing: Sales figures aren't enough. You also need to know when you will receive the money. Good cash flow depends on prompt payment of invoices. If some of your clients are on 30-day terms but actually take 50 days or more to pay, you must take that into account here. It's the reality that matters, not the ideal scenario.
Expenses / costs: You should include both fixed costs and variable costs here. Fixed costs are expenses that you will incur regardless of sales figures, such as salaries and office rent. Variable costs are those that depend on the volume of sales you make, such as buying raw materials for manufacturing products.
How GoCardless can help with your cash flow
One of the three main components of a cash flow forecast, as mentioned above, is payment timing. The quicker you get paid for your invoices, the better and more predictable your cash flow will be. This is true right now, not just in the future – faster payment equals better cash flow and a more stable business.
GoCardless allows you to improve payment times and make your income more predictable. By encouraging your customers to use Direct Debit, GoCardless takes the stress out of chasing invoices and waiting for payment – by pulling funds from your customers’ bank accounts each time a payment is due.