Your cash flow forecast is all about predicting the money your business is going to need, and when it’s going to need it. Even if you have the best strategy and the strongest team, it all means nothing if you don’t have enough money to pay the bills.
Simply put, you never want your business to run out of cash, and your cash flow forecast helps you predict when your bank account might run low.
Before we go too much further, there’s one important thing we need to get out of the way:
Profits aren’t the same as cash.
Profitable companies can run out of cash, and they frequently do because of poor cash flow planning.
Why aren’t profits and cash the same?
Here’s a very quick explanation of why profits aren’t the same as cash:
When your business makes a sale to a customer, but that customer takes 30 or even 60 days to pay their bill, the amount of the sale does show up on the Profit and Loss Statement (also called a P&L or income statement), potentially increasing your profits. But that cash doesn’t show up in your bank account until the customer actually pays you. So, your business could make a lot of sales and be profitable, but at the same time be low on cash because customers haven’t actually paid for their products or services yet.
If you want more detail on this topic, you can read our article on the difference between cash and profits.
Today, we’re going to talk about three critical factors that you need to pay attention to when you’re creating your cash flow forecast. If you are looking for a broader guide to give you a good understanding of how to forecast cash flow, check out our guide to forecasting your cash flow and our detailed explanation and definition of cash flow.
And, if you need a tool that will help you create a cash flow forecast without the headache of spreadsheets, we recommend LivePlan.
1. Cash from receivables
First, let’s define “receivables.”
This is accounts receivable—the money that is owed to you by your customers. If you send out invoices and then wait for customers to pay you, you have accounts receivable and you’ll need to understand how it impacts your cash flow.
The first thing to think about is the percentage of your total sales that are “on credit”—the percentage of sales that you send out invoices for. If you sell exclusively to other businesses, it’s likely that 100 percent of your sales are on credit. If you get paid immediately by some of your customers and send out invoices for other customers, you’ll want to estimate the percentage of your sales that are on credit, versus the percentage that are paid immediately.
The reason you want to do this is to figure out what percentage of your sales will end up in the “accounts receivable” row of your balance sheet. When you get paid, your accounts receivable will decrease, and you will record the new cash you’ve just received on your cash flow statement.
The other factor you want to consider is the average time it takes for your customers to pay you—“days to get paid.” Even though your invoices may say “Net 30,” there’s a good chance that on average, your customers pay you in 45 days instead of 30 days. Take a good guess at this number and use this as an estimate for forecasting your cash flow.
Remember, this is general planning, so it’s okay to estimate the percentage of customers that take the time to pay you and the average number of days it takes for them to pay you.
You can certainly do all of the forecasting and calculations in a spreadsheet, but I prefer to use a tool like LivePlan to help forecast my cash flow because I don’t have to mess with complex spreadsheets and instead can spend time focusing on the end results and business strategy.
Experiment with different variables for “days to get paid” and the percentage of sales that you have “on credit” and you’ll see how changes in these numbers can have a big impact on your cash flow.
For planning and forecasting, you can fix potential cash flow problems by trying to get your customers to pay you faster, or by not allowing as many customers to pay on an invoice. Changing these numbers can put cash in your bank account faster.
2. The impact of payables
Payables are the opposite of receivables. This is money that you owe your vendors. You may have purchased something for your business and received a bill. Until you pay the bill, you’ll record this money that you owe on the “accounts payable” row of your balance sheet. When you pay the bill, you’ll reduce your payables and the cash will leave your bank account and reduce your cash on your cash flow statement.
Just like you did for receivables, you’ll want to play with two different variables: the percentage of your purchases that you make “on credit,” and the average number of days that you take to pay your bills.
You can work with these numbers to impact your cash flow forecast. Perhaps you can pay your vendors slower, which will keep cash in your business longer, or perhaps you can pay for more of your purchases on credit.
If your business manages inventory, that is the third key factor that can have a major impact on your cash flow forecasting.
Inventory is recorded as a cost when you sell your product—you only record the costs directly related to what you sold in a given month. This is what will show up on your profit and loss statement. So, if you plan to sell 100 widgets next month, and each widget costs you $20, you’ll forecast an inventory cost (officially, a Cost of Goods Sold) of $2,000 on your profit and loss.
But, you may have purchased 1,000 widgets several months ago and those widgets are sitting in your warehouse. The cash that you used to purchase those widgets comes off of your cash flow forecast when you actually pay for the widgets and is not an expense on your profit and loss.
So, anytime you purchase new inventory, the money will come out of your cash flow forecast, and the inventory you’ve purchased will show up as an asset on your balance sheet.
This can be a bit confusing, so again, I prefer to use a system like LivePlan to experiment with my inventory assumptions. Based on your sales forecast, it will automatically figure out how much inventory to purchase and when you need to purchase it. You tell the system the minimum inventory you would place an order for, and how much inventory you want to keep on hand at a minimum.
Of course, you can do all of this in a spreadsheet if you want to build your own forecasting model for inventory. And here’s a template for building a cash flow statement in Excel.
The three key assumptions that we’ve talked about here can have a significant impact on your cash flow. Use a tool like LivePlan to experiment with different variables to figure out when you’ll be short of cash, and what you and your business can do about it.
Editor’s note: This article originally published in 2016. It was revised in 2019.