How to build a cash flow forecast
To build a cash flow forecast, list the cash coming in and going out for each future period, apply the timing on which money actually moves rather than when it is invoiced, add tax and financing, then carry the closing balance of each period into the next. The result is your bank balance, month by month.
A cash flow forecast is not a complicated document. It is a list of money in, a list of money out, and a running balance. What makes it hard is timing: almost every mistake in a cash flow forecast is a right number in the wrong month.
1. Decide your horizon and period#
Weekly for thirteen weeks if cash is tight and you are managing it hand to mouth. Monthly for one to five years if you are planning, budgeting, raising money or applying for a loan. Pick one deliberately, because it changes what the forecast is for. A monthly view will not show you that payroll leaves three days before your biggest receipt arrives.
2. Start from your opening bank balance#
Everything you could actually spend today, across every account. Not your profit, not your invoiced revenue. If you have money owed to you or bills you owe from before the forecast starts, note them separately, because they will land inside the forecast period and are easy to forget.
3. Forecast money in, on collection dates#
Work out what you expect to sell in each period, then move it to the period you expect to be paid. If you sell on 30-day terms and your customers average 45 days, use 45. Be honest here rather than optimistic: this single assumption moves a cash forecast more than almost anything else.
If you are VAT registered, the VAT you charge is money in that you are holding on somebody else's behalf. Include it when it arrives and take it out again when you pay it over, rather than netting it off and losing sight of it.
4. Forecast money out, on payment dates#
Payroll and the taxes on it. Rent, utilities, software, insurance, professional fees. Materials and stock, on the terms your suppliers actually give you. Marketing. Anything annual, in the month it falls, rather than smoothed across twelve. Smoothing an annual insurance premium is the classic way to make a bad month look fine.
5. Add the lumpy items people forget#
VAT payments, quarterly. Corporation tax, annually and usually nine months after year end. Equipment purchases, in full in the month you pay rather than spread as depreciation. Loan repayments, including interest. Dividends. These are the items that turn a comfortable-looking forecast into an overdraft.
6. Carry the balance forward#
Opening balance, plus money in, less money out, equals closing balance. That closing balance is the next period's opening balance. Repeat to the end of the horizon. The row of closing balances is the forecast, and the lowest number in it is the one to look at first.
7. Then make it useful#
A forecast you build once is a document. A forecast you keep is a tool. Two habits make the difference: compare each period against what actually happened, so you learn which assumptions are wrong, and build at least one downside version, so you know how much room you have before the plan stops working.
Doing this without a spreadsheet#
Every step above is mechanical, which is why software does it well. The two approaches are to project your accounting history forward, which is quick and works while the future resembles the past, or to model the business from its drivers and derive the cash flow, which takes longer and works for a business that has no history or is planning a change.