Cash flow forecasting should be a fundamental component in your business management and planning. It allows you to navigate difficult business environments or seize growth opportunities promptly.
Some businesses choose to operate without a formal cash flow forecast for various reasons. This can leave a business dangerously exposed in hard times or when the business needs to demonstrate its sustainability to external parties to expand or fund business opportunities.
Cash flow forecasting is often neglected, possibly due to a real or perceived lack of time and resources. Complacency or scepticism can arise where there is a history of managing without forecasting or where there is a belief that predicting the future is impossible. Some businesses may believe that an annual budget is sufficient.
Failing to prepare for the future is a costly mistake
Cash flow planning is not a test of your ability to predict the future but a requirement to plan for possible outcomes. A rule of thumb is to have a three-month cash flow forecast. This timeline is short enough to reduce uncertainty but long enough to allow time to react.
Five tips for cash flow forecasting
1. Start by determining what you know
- When and how much are your payroll runs and any other payroll related expenses?
- When and how much are your debt servicing obligations? What are the debt covenants?
- How much cash do you need each month to cover non-discretionary expenditure?
2. Consider options to increase flexibility or certainty
- Which payments can be legitimately deferred?
- Which payment terms (with customers or suppliers) could be negotiable?
- What discretionary spending has been cut and could be further cut if necessary?
3. Be flexible
- Consider more than one outcome in your forecast e.g. timing of receipts or the start of growth.
- What are your red flags e.g. the events or metrics which would require you to take further action.
4. Ensure your forecast is consistent with reality
Consider your forecast in the light of your profit or loss and balance sheet (a 3-way forecast). It is easy to forget key items.
- Have you considered all expenses?
- Have you considered the timing and amount of all receivables and payables, especially if any amounts deferred?
5. Review your forecast regularly
Constantly review your cash flow forecast and update it for new information. Remember to beware of excess pessimism as much as unfounded optimism. Ensure that your cash flow forecast is always rolling three months ahead, and recognise that preparing a cash flow forecast should not be reserved for emergencies. Instead, it should be an integral part of your overall business management strategy.