What is a cashflow forecast, exactly?

What is a cashflow forecast, exactly?

What is a cashflow forecast, exactly? 1200 630 Colin Kennedy
Image: Cashflow chart

Most people nod in agreement when they hear the fable of the ant and the grasshopper – the ant worked all summer while the grasshopper lazed about, only for a starving grasshopper to come begging at the ant’s door in winter.

However, it’s surprising how few business leaders apply the common-sense lessons the fable teaches.

Many could be forgiven for thinking that the fable is about the value of hard work, and it is to an extent, but it is also a story about prediction and preparation – know what’s coming and prepare for it.

Your stock standard cashflow forecast is an essential tool for this purpose.

In its most basic form, a cashflow forecast is a table that ‘predicts’, over a specific time, a) the money the business expects to receive, and b) the money the company expects to pay out – in essence, how much money you expect to have on hand in any given period.

The benefit of a cashflow forecast is that it allows you to predict the lean times, like winter for the ant, and the good times, like summer for the grasshopper. Summer and winter are pretty straightforward, but real-life business is far more complex and needs to consider, for example, factors like seasonal variables, capital expenditure and increases in expenses like rents.

A cashflow forecast is not a sales forecast, which concerns itself with predicted sales in the coming period and sometimes errs on the side of optimism.

The cashflow forecast should include expected sales but err on the side of conservative – sales aim for the stars, the cashflow forecaster settles for the moon.

1. Determine the period

The ant and the grasshopper concerned themselves with summer and winter. Business leaders will often prepare an annual cashflow forecast, but some argue it’s best to take the ant’s lead and forecast for a shorter period – even six months, or at least plan to review your cashflow forecast quarterly.

2. Predict your income

Look back over the last couple of years to get a handle on averages as well as the ebb and flow of cash, accounting for seasonal fluctuations and unforeseen variables that have impacted you in the past. Some would argue that basing your cashflow forecast on past performance is looking back, not forward, which is why using your sales forecast is important. Your historical financials may help you temper the optimism of the sale forecast towards realism.

3. Add your costs and outgoings

Don’t leave out the small expenses because they quickly add up. Remember that not everybody pays on time. Kiwi SMEs wait on average 24.1 days to get paid, according to Xero’s Small Business Insights for December 2020. Consider the risks associated with cost increases, like telephones and other fees. Plan for the best, expect the worst.

4. Put your cashflow forecast to work

A good cashflow forecast will give you an idea of what to expect so that you can prepare now to address any issues. If, like the ant, you note that the winter months of June, July and August will be tight, take steps to prepare better or improve the situation.

In the words of Sir Richard Branson, “Never take your eyes off the cashflow forecast because it’s the lifeblood of the business”.

Tax Management NZ has produced a guide called Better Cashflow Management. You can download your free copy here.