The cash flow forecast

Author: Jim Riley Last updated: Sunday 23 September, 2012

Finance - The Cash Flow Forecast

The cash flow forecast predicts the net cash flows of the business over a future period.

The forecast estimates what the cash inflows into the bank account and outflows out of the bank account will be. The result of the cash flow forecast is an estimate of the bank balance at the end of each period covered (normally this is for each month). An example of a simple cash flow forecast is shown below:

£'000	Jan	Feb	Mar	Apr	May	Jun
Cash at start of month	25	20	15	5	10	20
Cash inflows	20	25	20	15	20	25
Cash outflows	25	30	30	10	10	20
Net cash flow	-5	-5	-10	5	10	5
Cash at end of month	20	15	5	10	20	25

A business uses a cash flow forecast to:

Identify potential shortfalls in cash balances – for example, if the forecast shows a negative cash balance then the business needs to ensure it has a sufficient bank overdraft facility
See whether the trading performance of the business (revenues, costs and profits) turns into cash.
Analyse whether the business is achieving the financial objectives set out in the business plan (which will almost certainly include some kind of cash flow budget)

Why the cash flow forecast is so important

If a business runs out of cash and is not able to obtain new finance, it will become insolvent. It is no excuse for management to claim that they didn’t see a cash flow crisis coming.

So in business, “cash is king”. Cash flow is the life-blood of all businesses – particularly start-ups and small enterprises. As a result, it is essential that management forecast (predict) what is going to happen to cash flow to make sure the business has enough to survive.

Here are the key reasons why a cash flow forecast is so important:

Identifies potential shortfalls in cash balances in advance – think of the cash flow forecast as an “early warning system”. This is the most important reason for a cash flow forecast
Makes sure that the business can afford to pay suppliers and employees. Suppliers who don’t get paid will soon stop supplying the business; it is even worse if employees are not paid on time
Spot problems with customer payments – preparing the forecast encourages the business to look at how quickly customers are paying their debts. Note – this is not really a problem for businesses (like retailers) that take most of their sales in cash/credit cards at the point of sale
As an important discipline of financial planning – the cash flow forecast is an important management process, similar to preparing business budgets
External stakeholders such as banks may require a regular forecast. Certainly if the business has a bank loan, the bank will want to look at cash flow forecasts at regular intervals