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Preparing cash flow forecast does not require a high level of skill in accounting.

Cash flow forecast is a vital tool you can use to control the financial aspects of your small business. Companies don’t go bust because they lose money; they go bust because they run out of money.

Most small businesses equate success with sales volume and profit. The reality is that a business can become insolvent in the middle of its best year in terms of sales and profits! Therefore there is a need to be very careful of cash flow where the business is growing rapidly.  Working capital is needed to fund growth. The reason some small businesses face liquidity problem is that many of them do not think about cash needs until after they are overextended.  When they suddenly find themselves in this situation, they try to borrow money in a frantic need and this is a bad idea. As you know, money is expensive especially when you need it most. Moreover banks are less likely to loan money when a business is overextended. The best time to get money is before you need it.

A cash flow forecast is a prediction of how cash will flow into and out of a business over a given period of time.  It’s the entrepreneur responsibility to monitor, measure, invest, borrow and collect enough money to operate the business. You should be able to predict future income and expenditures through budgeting and forecasting.  Entrepreneur should anticipate the cash needed to sustain the operation and should be able to arrange financing for cash flow short falls. He should also arrange short term investments for temporary cash flow surpluses. All this can be achieved through the use of cash flow forecast.

Benefits of Cash Flow Forecast

1. It summarizes the impact of all activities on the business
2. It shows how much money is required at any given time to finance all activities
3. It gives an early warning of cash flow gaps so management can readily adapt
4. It gives confidence to outsiders who might be called upon to assist in financing
5. It allows the small business to monitor and keep type control over their costs. 

How to Prepare Cash Flow Forecast

Preparing cash flow forecast does not require a high level of skill in accounting. It just requires following these four basic steps:

1. Identify cash inflows
2. Identify cash outflows
3. Calculate net cash flow
4. Adjust bank balances

Identify Cash Inflows

Cash inflows will include the following:

• Cash Sales
• Collection on Receivables
• Borrowed Funds
• Sale of Assets
• Investment Income
• Additional Input of Owner Equity

Identify Cash Outflows

These will include the following:

• Payment of Employee Wages
• Purchase of Materials for Jobs or inventory
• Operating Costs (Overhead Expenses)
• Loans Repayments
• Purchase of Capital Expenditures
• Payment of Taxes
• Owner Equity Withdrawal

Please note that depreciation does not count as it does not involve movement of funds.

Calculate net cash flow

You simply subtract total cash outflow from total cash inflow to find net cash flow. The equation is simple.  The hard part is how to accurately identify the sources defining the flow of cash. Your industry experience can be a vital source of information for cash flow forecast. Conducting a market research can reveal typical payment terms for customers and suppliers. You can also understand the seasonal peaks in term of sales. Market research can help you identify potential costs. Above all, professional advisers such as accountants and bank managers can be great for helping you put the forecast together. They can challenge the assumptions you made and check that the forecast is complete and accurate.

Adjust Bank Balances

Add net cash flow to bank balance for the beginning of the month to predict what’s going to happen by the end of the month. The cash balance at the end of a given month shall be the opening bank balance of the month following.

Common Problems with Cash Flow Forecast

Since cash flow is a prediction of future events, there is no way the accuracy of the information therein can be guaranteed. Some of the problems with cash flows are identified below:

Over Optimism

Entrepreneurs can be too optimistic about sales potential. At the end of the day, sales may be lower than what was projected.

Unrealistic Credit terms

A projection of cash sales may turn out to be credit sales while some credit customers may fail to pay within the allowed credit period.

Higher Costs

Cost may be higher than anticipated. This may be due to inflation or inefficiency

Error of Omission

Certain costs can be completely omitted from the forecast. This mistake is common with new entrepreneurs

How to tackle problems with cash flow forecasting

1. Make sure you are realistic about cash inflow (money not promises)
2. Avoid being too optimistic in terms of generating sales or keeping direct costs low
3. It’s useful to prepare “best case” and “worst case” scenarios. Scenarios are a way of developing alternative futures based on different combinations of assumptions, facts and trends. Building scenarios will force asking relevant questions and identify a range of possible choices or events, as advised by Roger Caldwell.
4. Involve experts in the preparation.

Read Also: Preparation of Financial Statements for Small Business

Business Planning