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Costing and cash flow: Your cash flow forecast  
 
Introduction

A cashflow forecast is a prediction of when cash will be received by your business and when it will leave. This helps you to spot any shortfall in cash before it hits you, and allows you to make arrangements to avoid running out of cash.

For start-up businesses, it is essential to know exactly how much finance you will need to take the business through its early stages, and to pinpoint when you will need it. The forecast is a key part of any business plan (more specifically the financial plan part of the business plan) from the point of view of potential funders.

Before you start

To be able to prepare a forecast, you will first need to forecast your sales and expenditure for the year ahead, estimating how much your business expects to sell and how much it will spend on the various business costs. Ideally, you should prepare a monthly income statement and balance sheet at the same time as the cash flow forecast - preferably all on a computerised spreadsheet. But even if you don't know how to work with computer spreadsheets, it is possible to do it with pen and paper.

We strongly recommend to go through the pain of compiling a cashflow forecast yourself. But if you get an accountant or a business advisor to do this exercise for you, be absolutely sure that you understand everything in the cash-flow forecast that he or she puts together for you. This factsheet will help you gain that understanding.

First read the factsheet on How to put together a financial plan, as this will give an overview of the information that needs to go into your cash flow forecast.

Receipts, payments and balances

A typical forecast is split into three sections (for an example, click here):

  • Receipts - all money coming into the business (for example, sales and loans);
  • Payments - all money leaving the business (operating costs); and
  • Balances - monthly balances and the cumulative balance.

Receipts' and 'payments' are not the same as 'income' and 'expenditure'. When you invoice a sale, it can be recorded immediately in the income statement. But until the cash is received, there is a corresponding entry of 'debtor' on the balance sheet.

Similarly, if you buy raw materials on credit, you will show the cost of materials on the income statement immediately - with a corresponding 'creditor' entry on the balance sheet. The cash flow shows you when you expect to pay out the cash for those materials.

The cash flow forecast shows when you expect to actually receive the cash. The cash flow forecast only shows cash moving in and out of your bank account, so it ignores non-cash items such as depreciation (the loss in value of assets through wear and tear or the passing of time).

Preparing the forecast

The following table gives you an illustration of a cash flow forecast for the first six months of a new business. It is a good idea to do a forecast for at least 12 months or longer, especially if there are loans to pay off; your cash flow forecast needs to show financiers that your business will generate enough cash to pay off the loan in the required time. For a Costs before start-up example, click here.

Set out your cash flow forecast as a table, with receipts and payments placed in columns in the months in which they occur. If the business is not yet trading, show the figures from the month in which the business is going to start trading.

Listing the receipts

Use the forecast sales figures from your income statement to put into your 'receipts' rows. If you run a cash business, you cash flow forecast is simpler because the cash comes in at the same time as you make the sale.

Credit sales

It becomes slightly more complex when you have credit sales, as you have to move the revenue figures into the future, as the cash will only come to you a while after the sale. When you sell goods on credit, there is a delay of a month or two (depending on the credit terms you give your customers) before you get paid. You need to build this delay into your cash flow forecast, by estimating how much of your sales will be on credit and then moving those amounts over into the next month or the month following that.

Remember, the cash flow forecast only deals with the actual cash coming into the business. So you have to estimate the length of time it will take to collect money from customers (typically at least 30 days from issuing an invoice). So the receipts would be shown on the cash flow in the month or two following their sale as recorded on the profit and loss account. As the example shows, the first credit sales would only be reflected as 'cash received' in the second month, although the goods have actually been sold in the first month.

Also show any grants, loans or savings that will be put into the business.

Listing the payments

Payments include general business costs as well as capital purchases and other charges. As with receipts, this can be linked to the Income Statement. Items for which you do not pay immediately will need an appropriate delay (say, a month).

Costs will include fixed costs for the business over a length of time (such as rent and salaries) and variable costs, which are related to production levels (such as cost of raw materials to manufacture the product).

Using the forecast

Once you have completed the forecast entries as far as possible, calculate the total receipts and payments for each month. Subtract the total monthly receipts from the total monthly payments and you will forecast a monthly balance of money in the bank. Enter the forecast bank balance from the end of each month as the opening balance for the next month. At the start of a business, the opening balance will be nil.

Now you can use the forecast to determine:

  • How much cash the business needs to meet its costs;
  • When an injection of cash is needed; and
  • How much personal income (drawings) the owners can allow themselves from the business.

Further reading

''Cash Flows & Budgeting Made Easy' by Peter Taylor (How To Books, 2000)

Relevant factsheets