Why do you need a cash flow forecast?

Before you dismiss forecasting on the basis that no forecast could have foreseen COVID-19, we need to consider what a forecast is. Cash flow is fundamental to all businesses. A cash flow forecast helps business owners and managers to foresee their future liquidity requirements and to proactively respond to changing market conditions.

It is built on a set of assumptions and is only as good as the assumptions that are used. You can bring in and change around many types of internal and external transactions to create various scenarios – both positive and negative.  Many of those assumptions will be based on historical events for example patterns of trading or upcoming expenses. The cash flow forecast will show you whether your business will be able to meet expectations; by comparing your actual income and expenses with your forecast you will be able to see which areas are under (or over) performing and react as necessary.

What forecasting does your business do and are you equipped to do it?

 

How to build a cash flow forecast

What accounting software does your business use? How familiar are you with its ability to create a forecast? You may feel comfortable to use the software yourself or your may wish to get some help from your bookkeeper or accountant.

If you want to build your own cash flow forecast then I would recommend using a spreadsheet package. Excel is the one I know the best but there are others around.

I’m not planning on using accounting terms, but we’ll use a generally accepted structure.

It’s good to start a few lines down and a few lines across to give you working space.

Open a new sheet and on the left hand side list out the different types of income that your business has, leave a few lines and start to list out the expenses. This should be a list of the in’s and out’s.

Across the top of the sheet list time going forwards in whatever time frame that you want you use in your cash flow, for example days, weeks, four weeks. months etc. It’s your choice. If you are using the cash flow to manage your business then I would suggest weekly and in some cases daily. If you are looking ahead over a longer time period, then monthly or four-weekly may be better.

It’s your decision – whatever suits your needs. Don’t forget that as you build you forecast up you may be able to show the figures in different time periods on different sheets.

Key elements to include in a cash flow forecast:

  • Estimated likely sales
  • Projected timings of payments – both in and out
  • Projected costs

Income – estimated sales forecast

You can make this however detailed you would like to.  Maybe break it down into income types for example by product or service or by customer. Look at your sales history for the last few years and then make various assumptions on how current and future trading conditions will affect these.  Alternatively you could leave this section blank for now and use the total expenses to tell you have much you would need to sell to match your expenses level. This is not recommended though as the more detailed information you have in your cash flow forecast the better decisions you can make.  

Timing of payments

Once you have input your sales forecasts you need to add when you expect payments to be received.  Assume most payments will be late (on average two weeks late as a starting point)

Expenses- estimated costs

Expenses are often grouped into fixed and variable costs.  

Fixed costs such as wages and rent will not alter regardless of how much income you are generating.  Add dates and anticipated amounts including all bills, fees, professional memberships.

Variable costs such as stock or raw materials will depend on your sales levels or another variable cost is how much marketing activity is undertaken.

If you can, group these items together in line with how flexible the expenses are. That will make it easier to focus on the costs that you have control over in the short, medium and long term. Please see the section on Deferred Payments which is particularly relevant to the current situation.

Tax and HMRC

If your business is VAT registered, money coming in and going our will usually include VAT. A cash flow can be more useful if the VAT part is split away from the value of a sale or expense. This will encourage awareness of what needs to be put aside in readiness for paying VAT over to HMRC.

The date of the upcoming payment to (or receipt from) HMRC for VAT should be a separate row on the spreadsheet showing when it will be paid.

The approach would ideally be taken to payment or refunds of other taxes, including PAYE, National Insurance and CIS.

How are the senior management going to be paid?

This section could be deemed to be on the very edge of the subject of this article. However, it is very important.

The relaxation of the wrongful trading restrictions during the COVID-19 pandemic are to allow businesses to avoid the need for insolvency at a time when there is great uncertainty over their future. These changes are yet to be tested and where a company can be shown to insolvent before COVID – 19 it is not expected that the changes will protect company directors against wrong trading allegations before COVID 19. The COVID – 19 relaxation of wrongful trading insolvency laws was retrospectively applied from 1 March 2020.

This no doubt a positive move on behalf of the government and one that I’m sure wasn’t taken lightly. It will be interesting to see when this relaxation will come to an end.

The good news is that this allows businesses breathing space to review, assess and rebuild.

I’ve not seen much on the subject of paying dividends from a company during the relaxed wrongful trading rules. If a company is insolvent it shouldn’t pay dividends. What I can imagine is that a company can be insolvent and not be criticised for wrongful trading but is still insolvent for the purposes of payment a dividend. 

If a company is deemed insolvent, it should not be paying dividends. The risk that those dividends could need repaying on the event that a company ends up in a insolvency process.

The point that I set out to raise is that if your company is paying dividends, they are payments from profit and that Corporation Tax will need to be paid on that profit in the future. You may choose to put some money aside each month so that money is there to pay corporation tax when it’s due.

Deferred payments – payment holidays

For many businesses Coronavirus has led to payments, that would have been due, being deferred. Some have also received grants or loans with reduced repayments in the short term. 

It’s important to be clear whether a payment that has been missed will need to be paid and when it will need to be paid. 

These future payments will need to be part of your cash flow forecast.

Rolling bank balance

Above the income for the first week add your business’ available cash balance. At bottom of that column, underneath all of the expenses, leave some room for totals – the available cash balance at the end of that period.

Combining Income and Expenses

Add in some totals after income and after the expenses. You can total your groups of income and expense types as you wish.

The available cash at the end of a period is the starting cash position plus the income and less the expenses.

The cash available at the end of the first period is the starting figure for the next period and so on.

If you give credit to your customers or are given time to pay by your suppliers then I’d suggest that you move the income groups that will be paid later and the supplier that you will pay later on to two extra sheets on the spread sheet.

This will mean that for the income and expenses that are paid later the totals for a period will be added into the cash flow in a different period to when the sale or purchase took place. This is a key difference to the static picture of an income and expenditure statement (often referred to as a profit and loss account) and a cash flow forecast. A cash flow forecast is about cash movement that is the result of activities by the business.

Link cells together to add flexibility to your cash flow forecast

The more the spreadsheet is linked together the easier it will be to update and then to test out different payment and performance positions.

I’m lucky in that part of our team is Spreadsheet Stu (his chosen nickname) and he loves building spreadsheets makes them do things that begin to show their and his abilities. If you don’t have a Spreadsheet Stu or have a friend of family member who could help, then your bookkeeper or accountant would be your next port of call.

The team at BusinessSupport.co.uk would be glad to help, but the level of information needed would ideally make it part of a deeper business review.

How to use your cash flow forecast

Once your cash flow model is in place you can begin to test different structures, staffing levels, sales levels and pretty much anything else that crosses you mind.

This forecast will be a big part of your review process undertaken as you follow through the business survival guide.

The cash flow forecast will form a key part of your business planning and monitoring as you go forwards.

Updating your cash flow

As your business moves forward it’s important to change the forecast as the reality differs from what was forecast. For example, a customer pays their invoice later than expected or sales are great than expected, that may mean a payment to a supplier is forced back or bought forwards.

The difference in an effective cash flow is moving from responding to cash flow to managing cash flow.

Developing your cash flow forecast

Your cash flow forecast will change and adapt as your business does and is a key business management tool.

If you do use a spreadsheet, please be sure to check that any calculations within the spreadsheet are correct and  that they add the correct range of figures.  Also check that any links between cells and sheets are accurate. If you can it is an excellent idea  to lock cells to prevent them from being changed by accident.

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