5 Steps To Building a Solid Cash Flow Forecast

I was floored when I learned that 82% of business failures are due to poor cash flow management. That is a staggering number and it made me wonder why more business owners don’t get help. Maybe their bookkeeper doesn’t know how to manage their cash. Maybe they don’t know where to start. Or maybe they just don’t realize it’s so key. Whatever the reason, I thought I’d offer some expertise in this area.
Cash flow forecasting is based on a simple formula: Beginning Cash + Cash Coming In – Cash Going Out = Ending Cash. Sounds fairly easy, but it is easier said than done. To simplify it, break down the process into 5 steps.

1) Beginning Cash – Start with an accurate cash balance from your accounting system. This is not the balance in your bank account. If your bookkeeper is keeping your books up to date, the cash balance in your accounting system is the most accurate number to use. That number will account for most transactions that have not yet hit your bank account (i.e. checks you have written that haven’t cleared, customer payments received that haven’t been deposited, etc.)

2) Cash Receipts – Determine the timing and amount of money you expect to come in. There are 3 parts to this.

• Start with your Accounts Receivable Aging. If your books are in good shape, you can run this report to see what customer payments are expected to come in and when. You may need to tweak your assumptions based on knowledge you have about your business and your customers.
• Second, you will need to determine the timing and amount of future cash receipts. This information should come from your sales forecast. Keep in mind that there may be timing differences between the day a sale is made and the day you receive the cash for those sales. Use history as a guide here.
• Last, there may be cash receipts you are expecting that are not part of the normal course of business. Things like insurance premium refunds, purchase rebates, etc.

3) Cash Disbursements – Determine the timing and amount of money you expect to go out. Here’s where it could get tricky, so it helps to think about cash outflows in categories.

• Purchases of products or services you are re-selling – Depending on how these items are paid for, you may be able to start with your Accounts Payable Aging. If your books are in good shape, you can run this report to see what vendor payments are expected to go out and when.
• From there, you will need to determine the timing and amount of future cash outflows. This information would be related to the purchases you will need to make to support your sales forecast. Keep in mind the payment terms you have with vendors – some may require payments or deposits in advance.
• Recurring Fixed / Overhead Costs – This includes things like rent, utilities, and payroll costs which should be fairly easy to forecast because the amounts and timing are usually predictable and consistent.
• Credit Card Payments – if you use credit cards in your business, you’ll need to forecast what payments will be due and when. We recommend using one credit card for recurring expenses with fixed amounts, and a different one for non-recurring expenses, or those that fluctuate with ebbs and flows in your business. That way, forecasting payments on credit cards is less complex.
• Financing Payments – Payments on outstanding loans and lines of credit should be fairly easy to forecast, given these are typically consistent
• Annual Insurance Premium Deposits – If you finance your insurance premiums, chances are you’re paying a large lump-sum amount up front at the beginning of your policy period. Remember to include those amounts in your forecast – they are easy to forget and may have a significant impact on your cash flow.
• Fixed Asset purchases – If you are planning on making large purchases of equipment or other fixed assets, remember to include any required upfront cash amounts in your forecast.
• Property tax payments – these are easy to forget as they only come up once in a while, but are often significant.
• Estimated tax payments – check your tax accountant to get the right amount and timing of payments to taxing authorities.

4) Compare Forecast to Actual – At this point, you can take your beginning cash balance, add your forecasted cash in, subtract your forecasted cash out to arrive at your ending cash balance. But you’re not done yet. The most important part of this process is to test your assumptions. You do this by comparing your forecast to your actuals. Start by comparing your ending cash balances over the next few weeks. If the numbers are way off, drill down into the various components to see where the variances are coming from. Are the forecasted cash receipts higher than actual cash receipts? Tweak your assumptions and formulas in your future forecast to get them closer to reality.

5) Now that you have a cash flow forecast that is reliable and accurate, you’ll want to make it easy to maintain. Use the data in your forecast as well as your historical data to develop go-forward assumptions that become the basis for formulas in your forecast. For example, find out what the inherent Days Sales Outstanding is (DSO) and use that number in a formula that will automatically forecast out your cash receipts from sales.
Although creating a cash flow forecast can be a time-consuming task, having a cash flow forecast for some businesses is a matter of survival. In that sense it is time well spent. Most businesses will use excel to build their first cash flow forecast, which is not a bad place to start. An excel-based cash flow forecast can work, but can be tedious to create and maintain. Thankfully, there are automation tools out there that can help with this process, and most of them integrate seamlessly with cloud accounting systems like Quickbooks Online, Xero and Intaact. Check out Float, Dryrun, or Futrli.

If you need help building a cash flow forecast for your business, or implementing a cash flow forecasting system, give us a call. We live this stuff everyday!