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Cash is the fuel for your business – you can’t operate without it! Cash flow forecasting is by far the most important cash management tool for business. It can be a daunting process, but taken step-by-step, the result will be invaluable in not only guiding your way to success, but measuring your progress.
Why Do I Need a Cash Flow Forecast?
Many profitable businesses fail due to lack of timely cash flow. A cash flow forecast enables you to manage your cash – NOT be controlled by it. You wouldn’t allow your business to run out of inventory, so why wouldn’t you manage your cash with the same urgency? The following are ways cash flow forecasting can benefit your business:
- Allows time to plan for both surpluses and deficits – proactive not reactive!
- Enables you to develop “what if” scenarios
- Reduces risk in making decisions that impact cash
- Helps identify how much cash you need to grow
- Profitability and cash flow are not synchronized, so understanding the timing of your cash flow is critical.
- A cash flow forecast is a requirement for raising capital from banks or investors.
- If you want to borrow money from a bank, you’ll need to provide a cash flow forecast.
Where Do I Begin to Prepare a Forecasted Cash Flow?
Initially keep the forecast very simple then develop detailed calculations over time. Consider cash as either coming in – “Source” – or flowing out – “Use.” As a starting point, review current financial statements and operating budgets.
Identify Sources
Collect data by identifying all “Sources” of cash. Typically, these sources are easily identified and include:
- Sales
- Deposits
- Collections of accounts receivables
- Note receivable payments
- Capital injections
- Loan proceeds
Identify Uses
To forecast the “Use” side, begin with a review of the Income Statement, starting with the Cost of Goods Sold section. If yours is a product-based business, there must be a clear understanding of how inventory is purchased, processed and delivered. If yours is a service business, then understanding the timing of payments to employees and subcontractors is critical. Owners of service businesses may be surprised by the amount of cash expended before receipt of payments from sales.
After creating a clear picture of Cost of Goods Sold, each operating expense should be reviewed in terms of timing. Then review the Balance Sheet of both assets and liabilities to determine additional cash outlays expected in the future such as:
- Purchase of fixed assets
- Sales of fixed assets
- Payment of accounts payable
- Credit card payments
- Loan payments
- Dividends or distributions to owners
A forecasted cash flow should include both a summary sheet and detail sheets for each Source and Use line which provides space to document assumptions. You need at least a three month cash flow by week, prepared monthly, and a twelve month cash flow forecast as part of the annual operating budget.
After preparing the first cash flow forecast there is typically a change in how the business operates, from a cash flow perspective, because of the insights gained in understanding how cash moves in and out of your business. There’s a lot to know when it comes to forecasting cash flow. But once you’ve done it you’ll wonder how you ever operated without this invaluable tool.
By Rick Arthur, CFO
Guest contributor Rick Arthur is a CFO with a CEO perspective, working with growth-oriented companies to implement financial intelligence. He brings financial goal clarity – improving cash flow, profitability and company value. With more than 35 years’ experience in senior financial roles and as the former owner of a $20 million company, Rick’s expertise encompasses hands-on accounting and creating big picture solutions for strategic planning, financing and growth. Learn more about Rick at www.cforickarthur.com or www.linkedin.com/in/rickarthur.
