In its simplest form, cash flow is the movement of money in and out of your business. It could be described as the process by which your business uses cash to generate goods or services for the sale to your customers , collects the cash from these sales and then completes this cycle all over again, therefore, a cash flow forecast is the lifeblood of your business.
When developing your cash flow forecast it is critical to take the following into consideration:
- How much cash does my business have?
- How much cash does my business need to operate, and when is it needed?
- Where does my business get and spend its cash?
- How do my income and expenses affect the amount of cash I need to expand my business?
Before you can answer any of these questions you will need to identify if all your company financial statements, budgets and other data is accurate and up to date. Developing a cash flow forecast without this knowledge is like building a house that has no foundations, eventually it will come crashing down around you.
The best way to avoid this is to make sure you have an experienced financial manager or financial director who can prepare and interpret all the necessary information and data. The problem is that many small and medium size businesses don’t have an experienced financial manager either because it is perceived that a full time resource is not needed or the cost is simply too high. If this is the case in your business then be advised that there are reputable companies that outsource brilliant financial managers on a part time or project basis. These part time financial managers are able to quickly asses and interpret financial statements, assist with formulating budgets and develop realistic cash flow forecasts for your business.
A cash flow forecast is the lifeblood of your business
A cash flow forecast is based on a series of assumptions about the expected performance of the business in the future. These assumptions need to be realistic and supported by the most accurate data you have available. If you have access to previous trading results then the best place to start is last year’s sales and expense records. Allocate these results into similar months in which they occurred last year, unless you know they will change in the future. You may want to increase sales to account for more growth or you may know that you made an unexpected sale/expense in a particular month last year that was a one off or extraordinary item. You could be looking at introducing a new product line or service, looking to buy a new piece of equipment or employ another person/s. These will all have an impact on the cash flow budget and are the type of things you should account for so that you can forecast as accurate a picture as possible.
If you plan to use the information on your profit and loss statement, understand that these have been prepared for tax purposes and will account for non-cash payments such as depreciation. This shouldn’t be included in a cash flow budget as you don’t physically result in any cash movements.
If the business is new, then you will need to base your assumptions on research, market expectations, contracts held, known expenses such as rent or compare other similar business results. The more information you can build into the picture the stronger and more accurate your cash flow forecast will be.
Photo credit: afm.org.uk