Charlotte Reeves
Why a cash flow forecast is worth the effort
Profit and cash are not the same thing. A business can be profitable on paper and still run out of money, simply because the timing of money coming in does not match the timing of money going out. A cash flow forecast is the tool that shows you this before it happens.
Think of it as a rolling monthly diary of your bank balance. Done well, it takes an hour or two to set up, then a few minutes each month to keep current. In return, you get early warning of tight months, the confidence to plan purchases and pay rises, and evidence to show your bank or an investor if you ever need funding.
You do not need expensive software. A spreadsheet with one column per month and rows for each type of income and spending is perfectly adequate for most small businesses.
Start with your opening balance and realistic income
Begin with the money you actually have in the bank on day one, not what you hope to have. Then list your income lines, separated by type, so you can see where the money really comes from.
- Sales receipts, not invoiced amounts. If you invoice in March but customers typically pay in May, the cash belongs in May.
- Recurring revenue such as retainers, subscriptions or contract payments, which you can forecast with reasonable confidence.
- One-off or uncertain income, such as a big project, a grant or an asset sale. Put these in, but mark them clearly so you can see what happens if they slip.
- VAT repayments and any other refunds you are expecting.
Be honest about payment terms. If your average customer takes 45 days to pay, forecasting on 30 days will flatter every month of your forecast. It is far better to build in a delay you can beat than one you cannot.
Map out your regular outgoings
Next, list everything that leaves the business account, again by category. Fixed costs are the easiest place to start because they repeat at predictable amounts and dates.
- Rent, business rates, utilities and insurance.
- Wages, salaries and subcontractor payments, including the pay dates rather than just the month.
- Employer's National Insurance, pension contributions and PAYE, which leave the account shortly after payday.
- Loan repayments, lease or hire purchase payments and finance costs.
- Software subscriptions, phone and broadband, accountancy fees and bank charges.
Where you can, put the date as well as the amount. A month with rent and wages due on the same week looks very different from one where they fall at opposite ends.
Do not forget irregular and one-off costs
This is where most forecasts go wrong. Annual and seasonal costs are easy to forget because they do not appear every month, yet they are rarely a surprise when you sit down and think about them.
- Tax bills. Corporation Tax is usually due nine months and one day after your year end. If you are self-employed, Self Assessment payments often fall on 31 January and 31 July, with payments on account catching people out in their second year of trading.
- VAT. If you are on quarterly returns, one month in three will carry a larger payment. If you are on the flat rate scheme or annual accounting, adjust accordingly.
- Seasonal stock. Retailers and hospitality businesses often buy heavily before a busy period, so cash goes out well before it comes back in.
- Equipment and repairs. A replacement vehicle, a new laptop, a boiler service or an unexpected fix.
- Professional costs. Year-end accounts, a website rebuild, staff training, Christmas parties and staff bonuses.
- Your own drawings or dividends, which are a real cash outflow even though they are not a business expense.
Spreading annual costs across twelve months in a separate row can make the picture easier to read, but always keep a version that shows the actual payment month. Timing is the whole point.
Build in a buffer and test the what-ifs
Once your forecast is laid out, look at the closing balance for each month. Any month that dips close to zero, or below it, needs attention now rather than later.
A sensible buffer is one to three months of essential outgoings, held in reserve. If your forecast never dips below that line, you are in good shape. If it does, you have several options: chase overdue invoices, agree better payment terms with a supplier, delay a planned purchase, use an overdraft facility you have already arranged, or take on work that pays faster.
It is also worth running a simple worst case. Reduce your income by 20 per cent, delay your biggest customer by a month, and add a £2,000 unexpected repair. If the business survives that, you can sleep more easily. If it does not, you know exactly which lever to pull first.
Update it every month without fail
A forecast built once and never touched is worse than useless, because it gives false comfort. Set a recurring appointment with yourself, ideally on the same day each month, and do three things.
- Replace the forecast figures for the month just gone with the actual figures from your bank and accounting records.
- Review the differences. If sales came in lower or costs ran higher, ask why and adjust the coming months rather than leaving them optimistic.
- Extend the forecast so you always have at least six to twelve months of visibility ahead.
Keep an eye on your debtor list at the same time. A forecast is only as good as the assumptions behind it, and the most common assumption to break is that customers pay on time. A quick phone call or a polite reminder email often brings a payment forward by a week or two, which can be the difference between a comfortable month and a stressful one.
Do this consistently and your forecast becomes one of the most useful documents in the business, not a chore you complete once a year for the accountant.
