When you’re building your financial forecast for your business plan, there’s nothing more important than your cash flow forecast.
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.
5 ways to improve your cash flow forecasts
Today, we’re going to talk about five 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.
1. Remember profits and cash are not the same things
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. Here’s a very quick explanation of why this occurs.
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.
2. Cash from receivables
Accounts receivable is the money owed to you by your customers. If you send out invoices and then wait for customers to pay you, you have accounts receivable. This is not inherently a negative thing and can help you potentially increase sales with greater purchasing flexibility. You just need to understand how it impacts your cash flow.
Percentage of sales on credit
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 is 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.
How long it takes customers to pay
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 it as an estimate for forecasting your cash flow.
Remember, this is general planning. 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.
Combine and explore credit and time to pay variations
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.
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. That way I don’t have to mess with complex spreadsheets and instead can spend time focusing on the end results and business strategy.
3. 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.
Review the same variables from accounts receivable
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.
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. Again, I prefer to use a system like LivePlan to more easily 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.
5. Look at different scenarios
While you’re not predicting the future when forecasting, you are trying to answer questions. Specifically, with your cash flow forecast, you’re looking to answer questions about your cash position over the next week, month, three months, and so on. Questions such as:
What does my cash flow look like in 3 months at my current rate of spending? Will I have enough cash to support opening up a second location? What’s the best way to manage funds from a recent loan?
These “what-if” scenarios are one of the most useful aspects of forecasting. Rather than sticking
with one expectation, you can create multiple to help you prepare for several outcomes. Like with any forecast, we recommend you start with three:
- Worst case scenario: What your cash looks like due to a negative outcome
- Best case scenario: What your cash looks like due to positive growth
- Actual scenario: What you expect to happen with your cash flow
Running these scenarios will help you navigate different potential outcomes and visualize the impact of future conditions.
Maybe you’re expecting sales to slow down in the coming months, want to explore your cash position after a major purchase, or simply want to better understand how to effectively manage funding. In any case, knowing your cash position, and at least exploring the above scenarios will better prepare you to handle a crisis, surprising growth, or just maintain the status quo. The more that you explore scenarios and compare them to actual results, the better you’ll be at mitigating cash flow problems and improving your overall cash position.
Accurate cash flow forecasting is worth the effort
The five tips that we’ve talked about here can have a significant impact on your cash flow. It may take some groundwork, but it’s worth experimenting with different variables to figure out when you’ll be short of cash, and what you and your business can do about it.
Of course, you can do all of this in a spreadsheet. You can even download our free cash flow example here as a PDF or an Excel sheet to get a better idea of what your cash flow statement should look like. However, if you need a tool that will help you create a cash flow forecast without the headache of spreadsheets, we recommend using LivePlan.
With LivePlan, all of your financial reports, accounting data, forecasts, and budgets live in the same place. You can import up-to-date information automatically, create custom reporting dashboards and even review your current cash position with just one click. All of these features are designed to simplify financial performance tracking and help you take advantage of these cash flow forecasting tips.
Editor’s note: This article was originally published in 2016 and updated for 2021.