Running a business is a complex and time consuming business. Often company owners feel that they are so busy that any form of paperwork is simply another added strain that they don’t need.

But there’s one type of paperwork that is absolutely vital for all companies and accountants agree that if a company only completes one form of financial statement then it is should be a Cash Flow Forecast.

There’s a well-known saying; “Companies don’t die of lack of profit, they die of lack of cash” and never a truer word was said. In fact an unprofitable company can survive just as long as they have cash in the bank to pay their bills and one way of making sure that happens is to have a reliable and up to date cash flow forecast.

This is especially true of companies that operate in markets that are seasonal: hotels, garden centres and of course ice cream manufacturers all suffer from variable income. Not understanding the effect of this could be disastrous come the winter time.

It isn’t just the obvious firms that need to keep a close eye on their cash flow. Businesses that engage in large, medium to long term contracts also have to understand how they will fund themselves during the period when work is being done, suppliers and staff are being paid but there are no invoices to be settled.

Understanding the cash cycle and being able to predict what will happen and when is exceptionally useful for companies negotiating contracts. By knowing when they will be under cash pressure they can arrange stage payments or payments for materials to see them through until completion.

Finally businesses that are thinly capitalised, where they have little free cash or working capital must also keep close to their cash flow. Arguably it is more important for these companies as a short term issue could end up in a winding up order or worse, liquidation.

It is a fact that the majority of successful businesses complete cash flow forecasts in some form or other. Even the very largest use this technique to identify their requirements from month to month and plan their expenditure accordingly.

Completing a cash flow forecast is actually a fairly straightforward task if you have the right information at hand. Naturally there is an element of estimation involved but with the right skills and a little thought it can be a surprisingly accurate exercise.

How to complete a cash flow forecast

The overriding message has to be that you must remember that you need to be looking at cash in and out, which in most cases is different to a profit and loss forecast.

If we take the example of income. Let’s imagine a company invoices its customers on 30 day terms. For the majority of the invoices issued, payment won’t be received until the month after. This means that for the purposes of your cash flow forecast you’ll need to estimate sales, then work out when the cash is likely to hit your bank account and then deduct any late payers and bad debt.

When we look at payroll costs the picture is a little more mixed. Employees are invariably paid in the month that the costs hit the ledgers but payments to the taxman for PAYE and NICs and to pension providers are often made in the month after payroll.  Again this needs to be factored in.

Commercial rents in the UK are usually paid quarterly, so you’ll need to put in three months’ worth into your forecast on the quarter days and lease payments can either be monthly or quarterly depending on the deal so checking your contract is required here.

Each of the costs on your P&L needs to be looked at and the payment or receipt date factored into your cash flow forecast.

Remember however that some things on your P& aren’t actually cash costs. Depreciation doesn’t actually cost you cash on a monthly basis because the purchase price for fixed assets was paid at the time they were bought. Similarly any amortisation that gets added needs to be discounted.

Depending upon the size and make up of your business you will need to factor in taxation. In the UK tax for larger companies is paid quarterly in advance based on an estimate, with an adjustment at year end to account for actual performance. For smaller companies it is paid after year end. Understanding when this potentially large cash call will appear is very important.

Additionally take a look at your bank statement. You may well find a raft of direct debits and standing orders, not to mention bank fees and interest that also need to be taken into account.

Finally take a good hard look at the finished product. Are the timings correct? Are your estimates reasonable and realistic? If not make conservative adjustment because it’s much better to end up with more money than you expected at the end of the month than less.

Your final cash flow forecast will show you exactly where you are going to face pressure on your bank account. If there are times when you go into the red then you’ll need to think about how you can mitigate this by reducing payments or contacting the bank to increase your overdraft. Doing this in advance is always better than waiting until you get into trouble and then hoping you’ll get out of it.

Once you have a good working document then you need to make sure that you re-assess on a regular basis. How accurate were your sales predictions? Did more people pay late than you expected?  Refining your cash flow assumptions will make the next iteration even more accurate.

Finally it is important that the forecast isn’t done once and put into a cupboard. This should be a working document updated at frequent intervals. The best forecasts are revisited regularly, revised, updated and used to plan the operations of the firm.

Cash flow forecasts are a vital weapon in the armoury of businesses both large and small. Making a small amount of effort on a regular basis will give the owners confidence that they have their finger on the pulse of their company.

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