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Friday, October 30, 2015

The Importance of Cash Flow Forecasting to Developing a Business Plan

What is a Cash Flow Forecast?

A cash flow forecast is simply a statement showing the cash inflows that a business is expected to receive in a given period of time and the cash outlays expected during the same period. The difference is either a shortfall or a surplus. When combined with the opening bank balances, the forecast can be used to predict the ending cash position of the business at the end of the period. This is crucial as it lets you know whether or not your business will require financing at some point.

Why Is it Important?

One of the most common mistakes that a business makes is that it relies too heavily on a statement of profit or loss and the owners assume that as long as the business is making a profit that all is well. The problem with that assumption is that a business can be making a large profit and have all of its cash tied up in inventory or accounts receivable. The concept of timing does not really factor into the determination of profit, so that it does not, by itself give a good indication as to whether a business will  have enough money to pay its bills and pay its workers and owners. To know that for sure, you need to have an accurate cash flow forecast.

This is particularly important when making plans to expand. The reason is that many owners get so caught up in the excitement of growth when they are on a roll, that they don't consider how their cost structure and cash flow demands will change as their businesses grow.

What Are the Key Components?

There are essentially two major sections to a good cash flow forecast:

1. The assumptions and hypotheses underlying the calculations.
2. The calculations themselves, presented in columnar format for each period represented.

The assumptions are crucial because while some of the relevant expense numbers can be forecast with certainty, a large number of the line items in your forecast will require you to make one or more assumptions concerning:

1. General business conditions, such as inflation rates, exchange rates, interest rates, input prices, fees etc.
2. The impact of additional growth on expenses, i.e. whether the expense increases directly as the business expands, or whether the increase is based on different rates for different levels of expansion.
3. The rate of sales growth that can be achieved by various marketing initiatives.
4. The productivity rates that can be achieved by employees for particular job descriptions.
5. The approximate salaries that will have to be paid to employees that the business will need to hire over time.
6. How much space will be required for the business operations as the business expands.
7. What the changes in taxation rates will be as the business expands and so on.
8. Shrinkage rates, returns, and other losses in the normal course of business.

There are others, but hopefully you get the general idea.

The calculations themselves will consist of three basic sections:

1. A cash inflows section, which will develop the figures for the revenue generated for the period that is actually received during the period. In addition, the proceeds received from disposals of company property or from raising capital in the form of debt or equity is included in this section.

2. A cash outflows section that details all the expenses during the period that are actually paid during the period. So pre-payments for items like insurance, memberships, large purchases of supplies are reflected in full as they are made and are NOT spread over the periods to which they relate. Also included in this section are outlays made to retire debts, replace capital equipment or purchase new capital equipment.

3. An ending cash section that starts with the net excess or shortfall, adds the opening cash balances, and ends with the ending cash balance.

If you set your projections up this way in Excel, you will be able to see at a glance, where your business will run into periods of tight cash flow and will need financing.

Next week's post will explore the mechanics of actually developing a cash flow forecast: how to develop projections of sales and expenditures.

Have a great weekend everyone!


  1. how was last weekend's wedding?
    plans for Halloween?

    1. It was good - not mine though. Not much planned for Halloween this year. We don't usually get any kids around this neighbourhood. Steph and I will probably go out.