Understanding cash flow forecasts and cash flow management

You might not need an accounting qualification to be successful in business but understanding accounts will help you understand the basics of financial management accounts and be comfortable using standard financial tools and measures to monitor the performance of your business.

This article explains the importance of managing and forecasting cash flow and your cash flow balance.  The other main management accounting measures you need to keep a very close eye on are:

• The profit and loss account
• The balance sheet
  

Why cash flow is so important

Your business needs cash to survive.  Even if your business is profitable on paper, unless cash is flowing in to the business faster than it is flowing out of the business you will very quickly find yourself in a position where you are unable to pay your suppliers or your staff.  If this happens your business is insolvent and it is unlawful to continue to trade.  If your business becomes insolvent it will not survive unless you find some form of financial funding.

If you are a director of a limited company that is operating whilst insolvent you could be fined and will be barred from holding any directorships in the future.

See our article on Improving your cash flow for some ideas.

What does a cash flow forecast tell you?

Cash flow planning:

• enables you to analyse when you expect to get paid and when you need to pay your own bills so you can determine whether you have enough cash in the bank to pay your bills
• shows when there is likely to be a negative cash flow, ie a shortfall.  If the cash flow plan indicates this will happen you should arrange suitable finance in advance – a far preferable (and probably cheaper) option than trying to find working capital quickly once you hit a cash flow crisis
• shows when there may be a positive cash flow, ie a surplus.  If the cash flow plan indicates this will happen you can plan in advance how and where to use or invest it

Cash flow analysis

A typical cash flow forecast is divided into:

• receipts – which is all the cash coming into your business, such as sales revenue and any loans
• outgoings – which is all the cash going out of your business, such as sales costs, buying stock or raw materials, office overheads, wages and any loan repayments
• balances - a monthly cash balance, along with a cumulative cash balance which should be equal to the amount of cash (or overdraft) in your bank account.

Working out, or forecasting, your cash flow

The more accurately you can calculate your cash flow forecast, the more useful it will be in helping you predict the future position of your business. Cash flow planning and forecasting is typically done on a weekly or monthly basis depending on when you need to take cash out of your business to pay your bills.  In order to calculate accurate cash flow forecasts you will need:

• realistic forecasts for future expected sales (which probably does NOT mean taking the previous year’s sales figure and dividing it by 12 to show a monthly forecast for this year!)
• a realistic view on when you expect to receive payment for the sales you have made (which is not usually in the same month it was earned, unless you are a cash business or customers pay in advance)
• details of how much and when all your items of expenditure will need to be paid for. Look at the payment terms and conditions on all the items you have bought or agreements you have entered into.
• include details of how much and when any loan repayments are due
• if you have it, last year’s actual cash flow figures may help you to recall items you have forgotten about.
• if you’re registered for VAT you will need to show input and output VAT as separate items in your cash flow forecast

Your cash flow as a business management tool

Update your cash flow forecast with actual numbers as soon as they are available so the forecast becomes your actual cash flow position as you go through the year.

Review the cash flow forecast using the most up to date figures at least monthly so you can take corrective action before the cashflow situation becomes critical.

Do some ‘what if’ scenarios to determine the impact of, say, sales running at 5% below forecast, or costs increasing by 10%. This will show you where you need to focus your attention to ensure you hit your targets.

If it looks like you have a cash problem looming always take advice from a qualified accountant or business adviser first, rather than from an organisation that is going to loan you some money.

Where can I get a cash flow template?

Free downloads of cash flow templates to show cash flow examples and cash flow forecasts are available from the Microsoft Office Online website.

 

Want to know how to use MS Excel better? Try our online training courses including 'Analyzing Data and Working with Macros' and 'Filtering and Summarizing Data'.  Online courses available here.