What Is Cash Flow Forecasting? A guide for SMEs

Cashflow forecasting is the process of estimating the money that will come in and out of your business over a certain period of time. It’s a vital task for SMEs for a number of reasons. 

An accurate picture of your cash position in both the short and long term helps you avoid a shortage of liquidity in the business, build the foundation for effective budgeting and help stimulate growth by investing in marketing and hiring new staff. 

A 2022 survey conducted by Xero and Accenture found “found cash flow challenges are undermining the growth and operations of at least 9 in 10 small businesses in the UK.” The report also found that 94% of SMEs experienced at least one month of negative cash flow. 

This is a common issue that isn’t going away. Indeed, the current economic landscape with high rates of inflation puts an even greater focus on cash flow management. 

In this article we’ll cover the following key topics: 

Why your business needs to forecast cash flow

This point might seem simple, but it’s worth stating clearly. Your business needs cash to operate. Your suppliers, office costs, rent, software subscriptions, and most importantly, your staff all need paying at the end of the month. Over leveraging debt, or waiting on an invoice to be paid to cover your operating costs is a fast route to failure.

Cash helps you grow. The prospect of money coming in doesn’t pay for marketing budgets or job ads. If you want to accelerate your business in the near or short-term, you need to have an understanding of your future cash position. 

Many SMEs are at the mercy of bigger businesses that often operate much longer payment terms. In the fashion industry for example, it’s not uncommon for payment terms on goods to be as long as 180 days. When the payments come in less frequently than they go out, effective forecasting is crucial for your business’s runway. 

You can manage risk better. Developing a new product or strategy that involves a lot of upfront costs seems less risky with a positive bank balance.

Many SMEs take on debt to get off the ground. To keep the business afloat while paying off the bank or investors will take careful management of ingoings and outgoings both in the here and now, and in the future.

How to effectively forecast cash flow

Before building cash flow forecast ask yourself the following questions: 

These fundamental questions will help you understand how granular your forecasting should be. For example, if you need to pay off a loan in the next year, through a monthly payment scheme, you will need to forecast at least in monthly intervals. 

It can also help you find the holes in your current reporting. To build an effective forecast, you’ll need to have a grasp of all of your incomings and outgoings. Some payments can slip through the cracks. 

While cash flow management is integral to the functioning of the business, working towards a goal or project can help you find more motivation for the task at hand. 

Here are the basic figures you’ll need to complete your forecast:

Forecast your income or sales on any selected period: This can be weekly, monthly or quarterly depending on the length of your forecast. Look at your business’s previous year figures to try and find any trends. Adjustments can be made based on increase or decrease in sales.If you’re a new business and don’t have any past first-party data to fall back on, estimate your cash based on market data. 

Estimate your cash inflows:  This might not necessarily be from sales, but also from other sources. A few of these sources can be a loan paid back to you, sale of a capital asset or any government grant and tax refunds.

Estimate cash outflows: While calculating your expenses, figure out how much it costs to make your goods available. Beyond its normal running expenses, cash outflows can arise in other ways such as : buying new assets, ‘one-off’ costs such as loan establishment fees, loan repayments, or investing surplus funds.

Compile the estimates into your cash flow forecast: Start with your current bank balance then, add your cash inflows and deduct the cash outflows for each period. The number at each period’s end is your closing cash balance. Now, this amount would be your opening cash balance for the next period.

Review your forecast against business performance: It’s important to regularly review your cash flow forecast. Did a client take too long on an invoice? Did you have to purchase new employee equipment? Your bank balance and your projected number will likely never completely match, but should hopefully trend in a similar fashion.

What is the difference between short-term and long-term cash flow forecasting? 

There are two main kinds of cash flow forecasting: short term forecasting and long term forecasting.

Short-term cash flow forecasting: Standard projection intervals can include 30, 60 or 90 days. You can choose to use short term forecasting to predict short-term liquidity problems and make decisions about short-term investments. It addresses questions like:

Long-term forecasting: Long-term forecasting makes calculations for 12 months or more. It can even extend up to a span of several years. You can use this type of cash flow forecasting to predict your company’s ability to generate cash in the far future and to make long-term investment decisions. Long term forecasting helps you address questions such as:

Better management of your business’s cash flow could be the difference between sustainable growth, and failure. 

To find out how Pennyhills can help your business work towards a better future, get in touch today.