Posted on: 26 February 2014

Here’s all you need to know about cash flow terminology alongside an expert’s view on why your business deserves a cash flow forecast.

It can sometimes feel like the administrative side of running a business gets in the way of actually doing business. Invoicing, paying bills, banking, VAT returns…the list is a long one.

We spoke to Stuart Crook from Wellers Accountants who has shared his expert views on why SMEs should have a cash flow forecast, the reasons for and risks of not having one, and how to get it right.

What value can a regularly updated cash flow forecast bring to a small business?

  • Incorporating a cash flow forecast (and balance sheet and profit & loss (P&L) account) into their business plan and budget results in a much more accurate and realistic plan. Key information such as the number of sales required to maintain a desired working capital will be immediately available.
  • A business is able to pre-arrange temporary overdrafts at no extra charge if they are able to present their cash flow forecast to their bank manager or financier. The bank manager will have confidence that the business is being managed effectively and they will be able to repay the overdraft when they say they will.
  • If a business owner decides to sell their business, presenting an accurate and working cash flow forecast proves that the business operates effectively. This can add tangible value.

What are the main reasons businesses do not complete a cash flow forecast?

  • Many SME business owners think they know what cash is coming into and out of their business already, so they see little point in documenting it. But they are underestimating the amount of information that is included in a cash flow forecast, and so the picture it can paint about their financial position.
  • They don’t see the benefit because of the various assumptions that have to be made e.g. that customers will pay in 30 days. This may be less or more in reality and so doesn’t that make the cash flow inaccurate in the first place?
  • Time and cost are barriers. Whilst it is relatively straight forward to maintain a cash flow, it does take time and usually external support to set it up in the first instance and keep up good cash flow management practices.
  • They are often scared to see the reality of their business performance on paper – sometimes seeing the worse-case scenario is too much for people to bear.

What are the top three risks a small business is exposed to if they don't manage their cash flow properly?

  • Paying unnecessary bank charges and interest on those charges is a common consequence of a business having a cash flow problem. Many businesses end up paying too many bank charges, with further interest on those charges, to make last minute payments. If they have an accurate cash flow forecast they can plan ahead more and avoid such payments.
  • Businesses can end up borrowing unnecessarily. Businesses often end up using more costly finance options such as paying for items on expensive credit cards or having to resort to invoice discounting (note invoice discounting isn’t always a bad thing but it should be used constructively, not because a business desperately needs the money) – again these are often not necessary if a business can see in their forecast what money they will have at a particular point in time.
  • The worst case scenario is that a business will simply run out of money. By not ensuring that a business has enough working capital, they run the risk of not being able to pay their bills and an unpaid creditor is able to make a formal injunction for the business to cease trading. Sometimes this can be purely because money is not being chased effectively.

What information do business owners need to hand to fill their cash flow forecast in accurately?

  • Key dates e.g. when VAT, PAYE and other key payments are due
  • The working capital figure, ie the time it takes to turn your goods or services into cash in your hand
  • Conditions of your overdraft or other loan facilities
  • Interest rates for any loans, overdrafts and other credit
  • Credit terms for different customers – to give an indication of when money is due in

What mistakes are commonly made when filling in a cash flow forecast and how can they be avoided?

  • Often people ignore VAT on sales recorded and also bills to be paid. Therefore, at a glance a business owner may think they have a healthy working capital but some of this will be required to pay a VAT bill. Make sure any sales recorded include the VAT and that the typically quarterly VAT payments are also entered.
  • A balance sheet is not integrated into the cash flow. A business owner could have a cash flow forecast and a P&L account but they won’t be incorporating vital information from a balance sheet such as PAYE, fixed asset additions, repayment of loans and VAT. Make sure you have an accurate balance sheet and that you pull any relevant figures from that and the P&L account into the cash flow.
  • Whilst the cash flow needs to be integrated with a balance sheet and P&L account, the cash flow isn’t always adapted to factor in various credit/debtor terms. For example, you may make a purchase that should be recorded in the P&L this month but the money won’t actually leave your account until next month i.e. when it should be recorded in your cash flow forecast.

Back to basics - What is cash flow?

Your cash flow is the actual cash coming into and going out of your business over a given period. It refers to physical money that is paid into your bank or shop till and paid out of your account or wallet.

It is important to manage your cash flow because it avoids the most common cash flow problem: too much money going out of your business and not enough coming in, resulting in you running out of cash. Even if it’s temporary, this can render you unable to pay your suppliers or other businesses to whom you owe money, potentially resulting in you having to stop trading.

What is net cash flow?

Your net cash flow is the difference between the amount of cash coming into your business and the amount of cash leaving it in a certain timeframe. You can calculate your net cash flow on a daily, weekly, monthly or annual basis, depending on the complexity of your organisation, how much your cash flow fluctuates and how regularly you use up all your cash.

If you have a negative net cash flow, it means that more cash is leaving your business than is coming in. This might prompt you to chase your customers to pay your invoices. Or it might mean that you delay paying a supplier (within your terms of agreement).

Ideally you want to be in an overall positive cash flow position, in that there is more cash coming in than going out of your business over a period of time. You may decide that your net cash flow needs to be positive on a monthly basis, but that the odd small negative cash flow position can be tolerated on a weekly basis. However this depends on the degree of fluctuation in cash position that your business can bear – something you can only know when cash flow management is part of your regular administrative duties.

What is the difference between cash flow and profit?

Your cash flow refers to the amount of money you physically have moving around your business, whether that be in your bank accounts, your tills or in petty cash. In comparison, your profit is an accounting term that refers to the amount of money you have available to invest in the growth of your business, taking into account future payments you will make to others and future receipts that you expect from your customers.

The fact that these anticipated amounts are included in your profit on top of what you have actually paid and received means that it’s possible to run out of cash at the same time as being profitable. So to avoid having cash flow problems it’s vital to be confident you can answer the question ‘what is cash flow?’ and create a cash flow forecast even if your business is making a profit overall.

What is a cash flow forecast?

To make it easier to monitor their cash flow, businesses create a cash flow forecast. This is usually a month by month prediction of all the cash that will be coming into and going out of the business. It is based on information like when invoices are due for payment from customers, when standing orders and direct debits are due to be paid, and when capital purchases (such as new office equipment) are anticipated.

A cash flow forecast is an essential part of good cash flow management because it gives the business forewarning when there’s a risk of it running out of cash. This provides a valuable opportunity to adjust things in advance.

How to do a cash flow forecast

Creating your first cash flow forecast can be daunting. To get you started, we have created 2 templates:

These cash flow templates can be adapted to suit any small business, including contractors. They also include links to tips for effective cash flow management and how to avoid cash flow problems, such as how to manage your debtors and the importance of having a contingency.

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