How to project cash flow

Every business should have a spreadsheet of cash flow forecasts, predicting likely cash inflows and outflows for the year. Knowing exactly what will happen in the future is impossible, but a look at last years’ figures combined with a forward view of expected expenses and sales will enable you to make a reasonable estimate.

Your cash flow projections will serve as your business performance yardstick. If sales are above or below your forecasts, you can make monthly adjustments to your business decisions. You can also forecast worst case and best case scenarios to guide strategies and management decisions.

Forecasting sales

Unless you have set ongoing contracts, forecasting sales can be difficult. As a retailer or service provider you never know, from one day to the next, how many customers will walk through your door. Sales forecasts are usually based on a combination of your historical sales figures for previous years, current market conditions and how you expect your future sales to be affected by a number of factors, including: new marketing strategies, new products, the actions of your competitors, and other events outside your control.

Try not to prepare your cash flow forecast in isolation. Involve the right people to get the best forecasts and projections by talking to employees with relevant responsibilities, like sales and marketing, and purchasing and planning.

Sales history

Basing your sales forecast for the year ahead on your historical sales figures for the past year or two is the obvious place to start. Remember that fluctuations in sales may reflect:

  • Your product pricing. Increasing or lowering your prices can impact on purchases (and profit).
  • Changes in your industry market, including what your competitors are doing.
  • Any other changes in your business, such as the launch of new products or services, especially if they create a spike in demand.
  • Economic downturns, improving trade conditions or other factors that will impact on your sales.

Expanding into the export market, hiring additional sales staff, embarking on joint ventures or expanding to new locations are a few examples of events that could impact on your sales forecast.

If this is your first year in business, forecasting will be more difficult to predict accurately, because you don’t have historical records to refer to. Base your forecasts on the realistic outcomes of your sales tactics.

Sales tactics

Your sales forecast will also be affected by your future sales plans and strategies. Sit down with your sales and marketing team to get a feel for the likely success of plans and projects in the pipeline. For example:

  • Will you be embarking on a concerted sales drive and implementing a customer loyalty programme or a direct marketing campaign? In each case, define how many potential customers you hope to contact and the success rate you expect.
  • What new advertising and other promotional activities do you have planned, and how will these affect your sales? For example, a retailer adding a transactional section to their website might unlock sales from other regions, or even other countries.
  • How many enquiries do you expect as a result, and what percentage do you expect to turn into sales?
  • How much of your sales effort will be directed at repeat sales from existing customers?
  • Have a look at your order book. Do you have any confirmed orders, or have customers who usually order in advance who have failed to do so?

If forecast figures based on your sales strategies give a different picture to a forecast based on historical performance, you’ll need to analyse why, and then use the most likely outcome in your final forecasts.

It is important to remain realistic in your forecasts and avoid the tendency to use the hoped-for best case scenario in your forecasts if you are not likely to achieve it.

Seasonal patterns and special events

Remember to factor the seasonal patterns of your business and industry into your cash flow forecast. For example, a ski hire businesses needs to plan for the summer downturn.

Are there any special events or circumstances this year that you plan to use for promotions, like a major sporting event or a seasonal promotion?

Finally

Try to identify when you’ll be paid for sales, bearing in mind that payment is often slower than anticipated. This will be affected by the credit terms your offer, the effectiveness of your debt collection and whether people are able to pay you on time. You’ll also need to make a provision for bad debts, which are likely to be higher during an economic downturn.

Forecasting costs

It is usually easier to be more accurate in forecasting costs than it is to forecast sales. Your costs are likely to be either a percentage of sales, or an easily identified collection of input costs and overheads. You can analyse your historical records to identify the types of costs you’re likely to incur and can contact your suppliers for an indication of the actual costs, or anticipated costs, later in the year.

  • Fixed costs (also known as business overheads) such as rent, staff salaries and insurance costs are largely independent of the level of sales.
  • Variable costs depend on turnover or the number of sales. For example, buying in new stock or raw materials will only happen if you have sold your existing stock.
  • Semi-variable costs contain both fixed and variable components. For example, your power costs might include both a fixed component (for lighting and heating the office) and a variable component (for running production equipment). If you run a factory and sales are low, your power costs will be lower but not zero because there will still be some power costs, even if you are not running the factory at full capacity.

Identify the bills you need to pay and when you need to pay them by and put these into your cash flow forecast. If annual lump sum payments for accounting services or insurance are problematic, consider opting to pay these bills monthly to simplify your cash flow.

Be sure to include expenses that don’t relate to sales or operating costs in your cash flow forecast. For example:

  • Repaying loans
  • Tax and GST payments and receipts
  • Dividends
  • Personal drawings

Using your cash flow

Use your sales and expenditure projections to prepare your cash flow forecast. Ask for help if you need input from your staff, accountant, business adviser, or even other business owners.

Compare actual with forecast

The main use of a cash flow forecast is to compare your actual income and expenses with your forecast figures and identify the reasons for any differences, and review any decisions if necessary.

If sales are lower than forecast, you’ll need to ask the following questions.

  • Was the shortfall caused by lower sales volumes than expected, lower prices, or a different sales mix?
  • Is the market less buoyant than expected or is your market share below target?
  • Was a particular product responsible?
  • Is a particular location or department underperforming?

If turnover was higher than budgeted, analyse the reasons.

  • Were your budget targets too high or too low?
  • Was the increase in sales a once-off spike or the start of a trend?
  • Have sales been brought forward from future months? Will sales in those months now be lower than originally forecast?

Compare the timing of income with your projections.

  • Did sales campaigns take longer to have an effect than anticipated?
  • Were customers slower to pay than you expected?
  • Were there any differences in the timing of expenditure?
  • Were any costs brought forward or delayed?
  • Have suppliers’ payment terms or your payment policies changed?
  • How did costs vary in different parts of the business?
  • Have unit costs changed (and are the new unit costs likely to continue in future)?
  • Has the efficiency you use resources with changed?

Analysing the differences will help you to improve your ability to forecast future income and expenses and allow you to take action where needed. Do you need to change any assumptions on which you based your forecasts?

Your cash flow forecast projects your cash position month-on-month. This will help to flag cash flow issues that will need action. For example:

  • If your overdraft is projected to be close to, or over, your limit you need to take timely action. This may include: speaking to your bank manager as soon as possible, and increasing prices or slowing down on sales to avoid the risk of overtrading (running out of working capital). It is better to give your bank manager three months’ notice of when you’ll need additional credit, rather than three days’ notice.
  • If your cash position is extremely variable, you may need to analyse your cash flow in more detail to see if a problem is likely to occur at any point during a month.

You can also use your cash flow forecast to check whether you can meet tax obligations and any future debts or finance payments.

Next steps

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