Cash flow management is the lifeblood of any small business. Without a clear understanding of where your money is coming from and where it’s going, even the most promising ventures can run into trouble.
In fact, according to the Australian Securities and Investments Commission, poor cash flow management is cited as a factor in more than 40% of business failures. This is why crafting a cash flow forecast is not just a wise practice but an essential one for ensuring the financial health and sustainability of your business.
In this blog post, we will delve into what a cash flow forecast is, why it’s crucial for small business owners, and provide you with a simple, four-step guide to creating one.
What is a cash flow forecast?
A cash flow forecast is a strategy used to estimate the flow of cash in and out of your business over a specific period. It provides a snapshot of your expected income and expenses, allowing you to predict your cash position and plan accordingly.
Cash flow forecasting can help you to:
- Predict and prevent cash shortages by adjusting spending, negotiating with suppliers, or securing a business loan.
- Make informed growth decisions and assess the feasibility of expansion projects, new hires, or equipment purchases.
- Monitor financial health and identify trends such as increasing expenses or declining revenue.
- Pinpoint specific cash flow problems such as slow-paying customers, payment terms, and seasonal fluctuations.
Creating a cash flow forecast
Before you can get started with your forecasting, it’s important that you gather all the relevant historical financial data for your business. If you’re only just starting your business and don’t have any historical data, you can use industry benchmarks or estimates.
Key pieces of information to consider include:
- Sales and revenue data
- Expense records
- Accounts receivable and payable
- Seasonal fluctuations and trend
1. Project Future Sales and Income
The first step in creating a cash flow forecast is to estimate how much revenue your business is expected to generate over the specified period. Take a look back at your sales history and see if those figures will be similar over the short term. If you typically experience seasonal highs and lows, these should also be factored into your sales expectations.
Other influences that may impact your prediction will be things like marketing (have you invested more money into promoting your business or products recently?) and competition (is there a new player in your sector who could potentially take customers or clients away from you?). As with any good forecast, remember to build in a margin of error, as it’s very rare that your estimate will be exact.
2. Solidify Your Payment Terms
Anyone who has been in business long enough knows that just because you make a sale, it doesn’t mean you’ll receive the money immediately. In many instances, you’ll be waiting 30 or more days for clients to pay your invoice. These payment terms must be built into your cash flow forecast to provide an accurate prediction.
If your forecast shows you will be struggling with ingoings over the coming months, it might be time to speak to some of your regular clients to see if you can update your terms. Offering an incentive – such as 5% off for early payment – could help you get over any financial bumps.
3. Predict Your Outgoings
Accurately predicting your outgoing expenses is crucial for maintaining a healthy cash flow. This involves identifying and estimating all the costs your business will incur. Some of these costs will be fixed – such as rent and staff salaries – while others will be variable.
Here’s how to approach this step:
- List all expenses – Create a comprehensive list of all your business expenses. This should include fixed costs and variable costs (e.g., utilities, raw materials).
- Categorise expenses – Group your expenses into different categories, such as operational costs, marketing expenses, and administrative costs to better understand where your money is going.
- Include one-time costs – Don’t forget to include any one-time costs or irregular expenses, such as equipment purchases or annual insurance premiums.
- Account for contingencies – Set aside a fund for unexpected expenses to manage unforeseen costs without straining your cash flow.
4. Collate All the Numbers
The final step is involves bringing together your estimated sales, payment terms, and outgoings to get a clear picture of your finances.
An easy way to do this is to start with a figure – the current amount in your business bank account is perfect – then add to that number your predicted profits, and minus your expenses.
Here’s an example. You have a starting balance of $15,000 + $12,500 profits for the coming month – $11,000 in expenses = $16,500 total.
The number you are left with is your cash flow forecast, and while there will no doubt be some room for error, it will give you an idea of whether you can expect an overall profit or your expenses will outweigh any expected profits.
Make sure to regularly review and adjust your cash flow forecast based on actual performance. This will help you stay on track and make informed decisions.
“Effective cash flow forecasting is crucial for small businesses to maintain stability and growth. It allows you to anticipate challenges, seize opportunities, and ensure you have the necessary funds to keep operations running smoothly,” says Gary Rawlings, Managing Director of Ezi PL. “By regularly updating your cash flow projections, you can make informed decisions, avoid unexpected financial pitfalls, and plan strategically for the future.”
Remember, the key to a successful business is not just about making money; it’s about managing it wisely. Start your cash flow forecasting journey today and set your business up for long-term success.
Ready to take control of your finances? Contact Ezi PL to find out how our tailored commercial finance solutions can help.