How to make a cash flow forecast

Even profitable and successful companies can be weakened when faced with late payments or a customer insolvency. There is much to do to protect your business: picking the right customers to trade with, implementing processes to ensure invoices will be paid on time, integrating cash flow forecast management in all your investment decisions, or taking out a trade credit insurance policy.

It all starts with having an up-to-date cash flow statement and creating a cash flow forecast. Let’s have a look at the benefits of a cash flow forecast, how to calculate cash flow and how to make a forecast.

Running out of cash is one of the top reasons why businesses fail. A regular supply of cash is vital to any organisation so that it can pay salaries, bills, and invest in growth. Even companies that manage to make a lot of sales can become insolvent if cash flow is disrupted, for example, due to unpaid invoices.

Benefits of a cash flow forecast include:

• Improve decision making – by analysing what happened the previous month and creating a cash flow forecast of the months to come, you’ll be able to spot trends and enhance your decision-making.
• Reduce risk – you can use a cash flow forecast to identify potential risks and anticipate when your business might need more cash and prevent cash flow problems.
• Carefully plan investments – a cash flow forecast can help you identify the best moment to invest, such as when buying new expensive software or machinery.
• Create contingency plans – cash flow projections can be used to carry out scenario planning and help you prepare for unexpected events.

‘Free’ cash flow is how much cash is available for you to spend. To work out your free cash flow forecast, you’d use this formula:

Net income + Depreciation/Amortization – Change in working capital – Capital expenditures = Free Cash Flow

To help you use this formula, here are some common cash flow management definitions:

• ‘Net income’ is worked out by taking the revenue from sales and subtracting the cost of goods sold, selling, general, administrative and operating expenses, interest, taxes and other expenses.
• ‘Depreciation/Amortization’ are scheduled expenses used to reduce the carrying or market value of some assets.
• ‘Change in working capital’ is the difference between current assets (such as cash, customers’ unpaid bills, inventories of raw materials or finished goods) and current liabilities (such as accounts payable).
• ‘Capital expenditures’ are the funds you used to acquire, upgrade and maintain physical assets such as property, buildings, technology or equipment.

Once you know how to calculate cash flow, it’s much easier to understand how to forecast future cash flows.

A cash flow forecast uses estimated figures to give you an idea of what’s in store over the coming weeks and months. This is perhaps the simplest way to calculate it:

1. Pick a timescale – for example six months in the future – and estimate the value of your transactions over that period.
   
2. List the cash you would receive:
   
   • Start with a sales forecast (especially recurring invoices, which you can predict with some certainty)
   • Add other inflows such as investments, grants, asset sales and tax rebates
3. Separately, list the cash you would spend: future overheads, including salaries, rent, hardware, software and tax.
4. Use the Net Cash Flow formula (see above) to work out if you will have a positive or negative cash flow over the selected period: Cash Received – Cash Spent = Net Cash Flow.

In the example above, ‘Sales paid’ is the amount of cash received in a given month for goods/services supplied during that month. The “75%” note indicates that only three-quarters of the cash due for sales made in any month will be received during that month.

‘Collections of credit sales’ refers to the amount of cash received during a given month for goods/services that were supplied in previous months.

Thanks to your cash flow forecast, you can see whether you will have positive or negative cash flow over the coming months. In case of negative cash flow, you can take appropriate measures to prevent cash flow problems.

Don’t just rely on your cash flow forecast

Despite your predictions and your cash flow forecast, unexpected challenges can still occur. You should never wait to be in trouble to protect your business. The good news is that there are options to consider from improving your cash flow forecast processes, to keeping a buffer for rainy days or turning to trade credit insurance.

To learn more about protecting your cash flow, take a look at our cash flow management guide.