How to succeed with cash flow forecasts

25th January, 2016

Preparing an annual cash flow forecast can tell you a lot about your business.

It can warn you with plenty of time to spare that you’re not going to have enough cash to survive the next year without getting additional working capital — which is vitally important to know.

Or it could be the wake-up call you need to make some changes in your business. You might need to make a tweak or two, like increasing prices or shedding ineffective staff, or you could discover something more serious, such as you’re in a twilight business and it’s time to move on.

Preparing your forecast

It’s reasonably straightforward to prepare a cash flow forecast if you’ve been in business for at least a year. This is because you have the previous year’s actual cash movements to use a basis for the future, and you know what costs you incurred on a day-to-day basis.

If you (or your accountant) make use of a good accounting software such as MYOB Banklink, it’s a piece of cake because the software groups all your income and costs together in expense categories and can produce a spreadsheet report showing all your receipts and payments on a monthly basis over prior years. It’s then just a case of going through the figures line by line and amending these for impending changes and likely increases or decreases. The main categories involved are overheads and outgoings, cost of sales (or direct costs), and sales.

Outgoings and sales

Overheads are usually straightforward to predict. Outgoings include capital expenditure, drawings, GST and income tax, which you may need help with from your accountant.

Predicting sales can be trickier: will these be the same as last year, higher or lower? Have you increased your prices? Are you planning to discount? Are you getting more customers, or are you losing them?

Once you have decided on the sales, the cost of sales (or direct costs) are last. Do you mark up using the same percentage every time? Or do you vary this depending on the customer? What direct costs such as contract labour or disbursements will you outlay? What proportion of goods you buy for resale get knocked out cheaply or wasted?

Reading the forecast

So you’ve taken the plunge and prepared the cash flow forecast, and to your horror you find it’s not looking good because in month six you have a cash deficit of $15,000. What could this be telling you?

  • Your business is sound, but you need a cash injection before month six, perhaps because of the need to acquire more plant and equipment or because you need to tighten up on credit control.
  • You need to make some improvements in the business. Perhaps analyse which product or service lines should be dumped or whether you’re overdue for a price increase. Or maybe you need to grade your customers and work towards eliminating the Ds and Es, or introduce a simple job-costing system so you find out which jobs or team members need the boot.
  • You need to get better at marketing. Has your sales funnel dried up? Have you lost any customers without noticing? Have your clients stopped referring their friends? How is your conversion rate holding up? Knowing that sales are falling is not enough; you need to know why.
  • Your drawings are too high. Reducing them to a more realistic level may mean your business could keep you going until retirement.
  • Is it time to face facts and shut up shop? Sometimes it’s hard to accept that you’d be better off getting a job or looking for another occupation.

A cash flow forecast is not just something you need to prepare to keep your bank manager happy; it’s a vital business tool that can help you succeed in business as well as extend its life. Ignore their usefulness and value at your peril.