Creating & Understanding a Cash Flow Forecast

Creating a cash flow forecast for your business is one of the most important things you can do, many businesses fail because of poor cash flow planning, when often, with enough time and planning cash flow issues can be mitigated long before they become an issue. In this article we explain the importance of creating and understanding a cashflow forecast, detailing the steps every business should take to do this.

Kieran James
October 27, 2023

Before you begin to create a cash flow forecast, it’s important that you understand what a cash flow forecast is and what it isn’t. Please refer to our financial terms blog if there are any terms you don’t understand.

One of the biggest mistakes business owners make when creating a cashflow forecast is mistaking it for a profit and loss forecast. The difference in the two is in the timing of when cash enters or exits the business. So, if you made a sale and raised an invoice to a customer for £1000, this would show up on a Profit and Loss forecast. Although it’s important to record that the sale happened, the invoice may not have been paid yet so this wouldn’t show up on a cash flow forecast. Once the customer pays this will then appear on a cash flow forecast. 

There are many tools to help you create a cash flow forecast, from Excel to Google Sheets, your accounting software to a bespoke cash flow forecasting tool. To help you get started, we have included a free template at the end of this blog for you to download.

Cash Flow Forecast Process

Forecast Recurring and Contract Revenue

This isn’t relevant for all businesses, but for many, at least a portion of their income will come from customers who have signed a contract already for products or services. Adding these ‘knowns’ to your CFF is a great place to start.

You may have some revenue that is not contracted, but has been a stable source of income for some time. It makes sense to add these in, but it’s important to underpin any assumptions with data. Having access to information like customer average order value (AOV), customer lifetime value (CLV) and retention rates can allow you to forecast this recurring revenue more accurately. For example, you may run a software as a service (SAAS) business and need to account for customers who stop using your software. If you are tracking retention rates, you can see that you may retain 80% of clients annually, this allows you to forecast this 20% drop off on your cash flow forecast.

Forecast Your Current Sales Pipeline

Many businesses will have a sales pipeline (a list of prospects, opportunities, their value and their likelihood of converting). It’s important to first vet the quality of the data in the pipeline as many are built on emotions and feelings, these should be underpinned with a rigorous objective approach. A good model for ensuring your sales team create an objective sales pipeline is Customer Centric SellingⓇ. If you’re interested in going deeper, the book Customer Centric Selling: Field Guide to Prospecting And Business Development by Gary Walker is a useful read.

And again, a process of using existing sales metrics such as conversion rates through the stages of a sale can help translate this objective pipeline into useful data for a cash flow forecast. Having said this, don’t forget that a cash flow forecast is not based on when a sale happens, but when it is paid, so a metric like Time To Pay (TTP) measuring how long it takes on average for a customer to pay their bill can be a useful metric to track.

Add Projections

A) Based on Previous Year

For many established businesses, forecasting a scenario that shows similar numbers to last year is likely to be a sound method to create a cash flow forecast that will allow planning and budgeting.

B) Based on Marketing Data

Similar to having a robust sales pipeline, businesses are likely to need some robust objective data from their marketing funnel to be able to forecast with a semblance of accuracy. A marketing funnel is a series of steps a prospect takes from the first time they hear about your company until they make a purchase (and sometimes beyond this). It’s important to not only document this process, but also track it as it helps identify where you may be losing engagement from prospects. And by tracking the data a business should be able to start to create forecasts. For example, if you know that the average order value from a client is £1,000 and you know that for every £100 you invest in a Facebook advert you convert 1 client. You can anticipate that £1,000 investment in Facebook advertising will provide you with 10 clients and a revenue of £10,000. 

A certain volume of data is required to create realistic assumptions in this area. And there always comes a time where marketing metrics do not scale as the marketing channel becomes saturated or there are no more prospects to market to. For example, in a b2b business, you may want to reach out to heads of HR in Printing companies via Linkedin who are based in the Newcastle Upon Tyne, England. A look at Linkedin Sales Navigator as of the writing of this blog shows there are 98 of these individuals on Linkedin. If your marketing metrics show you convert 1 in every 10, there is still a limit of 98 people, so we can assume that the maximum conversions possible is 9.8 clients from the 98 contacts. At this point we'd need to use data from other marketing sources if we expected growth beyond this.

C) Based on Educated Guesses

A cash flow forecast is just that - a forecast, they can be wildly off the reality, but using data to underpin the numbers can provide a greater reliability. Despite this, there are always times, such as when starting a new business or entering a new market, where educated guesses are the best we have.

Forecast Cost of Sale

Hopefully, once you have forecast your sales out, it is easy enough to work out the cost relating to that sale. At this point most assumptions should be based on real life data. For example, if it costs £1 to produce a widget, you can assume it will cost £10 to produce 10. You may make an allowance for economies of scale, but this should be underpinned with the data you know.

Forecast Operational Expenses

The penultimate step then is to work out what the business will need in order to deliver on those sales forecasts, what people, systems, consultants, advisors, insurances, machinery etc.. and to add these into the forecast; where possible finding objective data sources to help, such as getting quotes from suppliers.

Forecast Investment and Funding

And finally, it may be the case that the cash flow forecast is showing that at some point the business won't be able to fund its growth plans. At this point, it’s important to identify what investment and funding is required and by when, in order to keep the business operating. It’s worth noting that investment and funding should only bridge short term cash flow issues (such as buying extra inventory to cope with demand) or support long term growth. Other than the ‘unicorn’ businesses out there, it’s rare for a business to survive long if there is no long term sustainable business model.

How Do You Use Cash Flow Forecasts to Mitigate Business Risk?

The simplest way to mitigate risk in most businesses is to plan. To create scenarios that allow you to see what you would do if certain things happened. This will be very unique to each business, but here are some examples:

·        A business who has a large customer that accounts for more than 15% of revenue could forecast what would happen if they lost that customer or if the customer delayed payment significantly.

·        What would happen if you lost your top team player, how would it affect the business, how much would it cost to help that person exit the business, manage any transition period, recruit, train and pay a new employee.

·        For businesses who pay significant VAT and can’t reclaim, they may forecast what changes in VAT might do to their business.

·        If you’re applying for a new large contract or tender, what would the effect be on your business?

It’s important for each business leader to identify the most likely areas of risk and to forecast based on these.

And the astute leader will also notice that in addition to a cash flow forecast, these scenarios will also require forecasting how to deal with issues relating to recruitment, operational capacity, customer service, inventory management, speed of procurement and much more. 

What’s the Point of Forecasting if They Aren’t Accurate?

Creating a forecast allows a business leader to look forward and spot when there may be occasions that more investment may be required, or if growing too quickly or slowly might cause potential cash flow problems. Once you know that your cash flow forecast is just one possible journey your business could take, it becomes clear that you should forecast multiple scenarios for your business. It's often recommended to create your cash flow forecast with what you expect will happen, and then forecast out a ‘best case’ and ‘worst case’ scenario.

However, even then it can sometimes be far from reality. During the COVID pandemic we saw cash flow forecasts thrown out the window because businesses ‘worst’ case wasn’t even close to reality. This is where using cash flow forecasts as a risk mitigation strategy can be really valuable.

Start creating your cash flow forecast today using our Free Cash Flow Forecast Template.

Blog & Article

Take a look at the latest articles

Request a Call Back

Leave your name and email address and a member of our team will be in touch.

Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.