Forecasting cash-flows is not always easy, especially if they tend to fluctuate a lot. Yet it is just when cash flows are unpredictable that a good Cash Flow Forecast is required more than ever. It is therefore necessary to deal with these uncertainties by making assumptions in your Cash Flow Forecast for both payments and receipts, not just in terms of timing but for the actual amounts as well.
Cash inflows will depend on sales in the first instance and on the timing of customer payments in the second. Neither can usually be predicted with a great deal of certainty so you will need to decide on how to estimate them. Sales may be predicted from orders already received from customers for the months ahead or according to recent trends. For example, if turnover for the year to date is 10% up on last year, you might assume that the next few months will also be higher than the year before. Sales revenue often has a distinct seasonal pattern and can be predicted according to the time of year.
Recent marketing activity can also be taken into account. For example, an advertising campaign may kick-start a previously moribund market, or a new brochure may breathe new life into your product range and attract more customers. Service companies dealing with a small number of large customers may be able to forecast revenue from recent contract renewals and new business pitches. Companies with a much larger customer base may forecast sales revenue according to what is happening in the economy as a whole or from how much competition there is from other suppliers in their local market.
As regards the timing of the cash flows, this can be based on your normal terms of business with adjustments for late payments. You should watch the recent pattern of late payments quite carefully as overdue accounts often build up over a few months almost unnoticed, especially when the economy is heading for recession. Indeed, late payments from customers are normally one of the first signs of an impending recession, even before sales revenue itself declines.
If you accept payment by credit card, timing of cash inflows may also be affected by changes in the terms and conditions for your merchant account. Banks often demand a high level of security for providing merchant accounts, particularly in certain industries such as travel where the risk is perceived to be high. They may require much needed working capital to be tied up in savings bonds, and if funds are not available for this it is quite common for banks to insist on retaining credit card receipts for a certain length of time instead, sometimes up to 45 days. This can impact on cash flow quite severely.
Outgoings are generally a lot easier to forecast as you have more control over when payments are made, and some will be at pre-determined times anyway, such as payroll, VAT and PAYE. However, costs that are directly related to sales or to the general level of trading activity will be more unpredictable. For example, if sales revenue increases it will be necessary for a company selling goods to buy more stock or raw materials. These must normally be paid for before your customer pays you, often before you have invoiced them or even sold the goods. This means that your cash reserves will run down fairly quickly and an increase in working capital will be required at some point. Your Cash Flow Forecast should enable you to detect when this will be.
You will need to make assumptions as to when additional costs will be incurred and when the cash outflows will occur. This will normally depend on current stock levels and existing capacities. For example, when will you need to hire more staff to cope with the increased workloads? When will you require larger premises? When will you need to buy more plant and machinery, office equipment or delivery vehicles? How long will your suppliers give you to pay for the stock? What is your normal stock turnover period? These are all questions that should be considered well in advance when you are projecting cash flows.
When a business is expanding rapidly, it is especially important to avoid the dangers of over-trading. This happens when the business runs out of cash due to a sudden increase in overheads or through holding too much stock in an attempt to meet the demand for its goods. Cash Flow Forecasts are vital to check that sufficient liquid funds are available to support the growth of the business. It may well be that existing cash resources are sufficient to handle the increased trading activity without the need to invest more funds, but it should never be assumed that higher profits will immediately translate into more money in the bank. Profit is most definitely not the same as cash-flow.
It is also important to forecast any spikes in your cash flow caused by one-off events. For example, the lease may expire on your main business premises or a rent review may be pending. You may have to pay dilapidations on the old premises when you move to new ones. You may need to invest in new fixed assets if the old ones are getting past their best, or there may be a big legal bill looming for some reason. Any large items like that should be highlighted in your Cash Flow Forecast as they are key variables and need to be monitored.
Sometimes cash-flows may be contingent on other events or the amounts may be indeterminate. In this situation, it may be best to consider a range of values and assign a probability score to each one, as you would in a Business Plan. You can then look at case scenarios and devise a strategy for dealing with each potential situation as it unfolds in a proactive manner, rather than being caught on the back foot and having to spend time fire-fighting and searching for solutions at the last minute. As in most areas of business, it is vital to think ahead.