Poor cash flow is renowned as being one of the biggest killers of startups and small businesses. In fact, many startups fail not because their fundamental idea isn’t sound or they’re not making money, but simply because they’re not able to manage the money flowing into and out of the business effectively.
One of the most common causes of cash flow problems is the late payment of invoices by commercial customers, but this is not something small businesses are powerless against. Research shows UK small businesses that regularly credit check their customers are around 30% less likely to fail in their first 12 months than businesses that don’t run any checks at all. The mismanagement of cash flow is also an issue, with KPMG reporting that the average small business relies on management accounts that are four months of out of date.
Given the severity of the consequences of a cash flow crisis, it’s essential you have full visibility of the cash in your small business and can plan for shortfalls in advance. To do that, you need a cash flow forecast.
Why is cash flow forecasting essential?
Far from being a nice-to-have, a cash flow forecast should be considered a small business essential for a number of reasons.
1. Better decision-making
Perhaps the biggest benefit of cash flow forecasting beyond mere survival is the ability to make more informed operational decisions. Knowing how much cash you have at different times allows you to make investment decisions with confidence, whether it’s hiring new staff, buying machinery or investing in stock. You can also delay investments or explore finance options if the forecast reveals a lean period ahead.
2. Reduce the risk of a crisis
Regular cash flow forecasting gives you an up-to-date and immediate view of the cash in your business and how that will fluctuate in the future. This can highlight problems that are approaching and give you time to take appropriate action before a crisis occurs.
3. Pay suppliers on time
Cash flow forecasting can prevent you from becoming a late payer yourself and potentially damaging your relationships with suppliers. Understanding exactly how much cash you have in the business now and in the future also allows you to take advantage of early-payment discounts that might be offered to boost your profit margins.
4. Understand how different scenarios will affect you
Another benefit of cash flow forecasting is the ability to see how different scenarios might affect the business. For example, will you be able to handle a 10% decrease in sales during seasonal drops in demand? Do you have enough cash in the business to move offices and still pay your staff? If not, you can change your plans before the situation becomes critical.
5. Improve collections and credit control
Creating a cash flow forecast will give you more visibility over which clients and customers consistently pay late. Using these insights, you can tighten your credit control process, reduce your payment terms if necessary and put more effort into chasing payments.
What should you include in a cash flow forecast?
A cash flow forecast is a relatively simple document you can draw up yourself without the assistance of an accountant. These are the items you should include:
For an existing business, you should look at last year’s sales figures and decide what adjustments you need to make based on current trends. If you run a new business, then start by estimating cash outflows and then think about the level of sales you’ll need to cover your outgoings.
2. Other cash inflows
Sales may not be your only source of revenue. If you are expecting a tax refund, receive a government grant, are expecting further investment or have royalties or licence fees, make sure you include them in your cash inflows.
You should take all of your expenses into account, including your fixed and variable costs. Fixed costs like rent and utility bills will remain the same the whole year, which makes forecasting them much easier. Other costs will be tied to your operating activity. That includes stock, wages, business mileage and your cost of sales. Try to predict how an upturn in sales will influence your variable costs.
4. Other cash outflows
There are also other expenses which often go overlooked. VAT payments on sales, the cost of loan repayments, drawings as the business owner and the cost of new office equipment should all be included in your expenses.
5. Bringing it all together
Once you have all these details, you will need to think about the period the forecast will cover and the opening bank balance. You can then add in all the cash inflows and deduct the outflows for each period, typically per month. The number you are left with is the closing cash balance, which becomes the opening cash balance for the next period.
Here’s an example of a simple cash flow forecast to give you an idea of what you should be aiming for. If your cash flow forecast reveals a shortfall, feel free to take a look at our blog about some of the different ways to improve your cash flow.
Keeping your cash flow in check
At London & Zurich, we offer a range of payment solutions for startups and small businesses to help keep your cash flow in check. If you’d like to find out more about our card payment and Direct Debit facilities, please get in touch with our team.