Forecasting
Cash Flows
Cash flow is important
• Cash flow is a dynamic and
unpredictable part of life
for a start-up or small
business
• Cash flow problems are the
main reason why a new
business fails
• Regular and reliable cash
flow forecasting can
address many of the
problems
Main kinds of cash flow
Cash inflows
Cash outflows
Cash is needed for…
Cash sales
Payments to suppliers
Receipts from trade debtors
Wages and salaries
Setting the business
up
Payments for fixed assets
Sale of fixed assets
Interest on bank balances
Grants
Tax on profits
Day-to-day
trading
Interest on loans & overdrafts
Loans from bank
Share capital invested
Dividends paid to
Growth
shareholders
Repayment of loans
Why cash flow forecasting is important
• Cash is king – it is the lifeblood of a
business
• If a business runs out of cash it will
almost certainly fail
• Few start-ups have unlimited finance
– cash is limited, so it needs to be
managed carefully
Why produce a cash flow forecast?
• Advanced warning of cash shortages
• Make sure that the business can afford
to pay suppliers and employees
• Spot problems with customer payments
• As an important part of financial
control
• Provide reassurance to investors and
lenders that the business is being
managed properly
Why start-ups suffer from cash flow
problems
• It can be a while before the business makes its first
sales – the pre-trading period often involves
incurring costs without getting any revenue in return
• Suppliers may demand immediate or early payment
because business does not have a track record for
paying bills on time
• A new business usually has to spend up-front on
expenses such as marketing and product
development
• The new business will not have reserves of cash built
up from profitable trading (“retained profits”)
Sources of information for a cash flow
forecast
• Entrepreneur experience
– Industry experience can prove vital
– Otherwise forecast has to include “gut feel” assumptions
(dangerous)
• Market research
– A crucial role – typical payment terms for customers, suppliers
– Reflect seasonal peaks and troughs in demand
– Helps identify potential costs
• Suppliers
– Very useful source of industry information
• Advisers (e.g. accountant, bank manager)
– Great for helping put the forecast together
– Can challenge the assumptions made
– Can check that the forecast is complete and accurate
What the cash flow forecast
contains
• Cash inflows (into the business)
–
–
–
–
Movements of cash into the bank
Receipts from customers
Investment by the entrepreneur
Loans from the bank or others
• Cash outflows (out of the business)
–
–
–
–
Payments to suppliers (materials, equipment, premises)
Payments to employees (wages & salaries)
Payments to lenders (e.g. interest, loan repayments)
Payments to shareholders (dividends)
Cash flow forecast - illustrated
Jan
Feb
Mar
Total
CASH INFLOWS
Investment
Sales
10,000
10,000
2,500
10,000
15,000
27,500
12,500
10,000
15,000
37,500
Raw materials
4,000
5,000
5,000
14,000
Wages & salaries
3,500
4,000
4,000
11,500
Marketing
2,500
1,000
2,000
5,500
Set-up costs
3,000
1,000
0
4,000
Other costs
2,000
1,000
1,000
4,000
Total inflows
CASH OUTFLOWS
Total outflows
15,000
12,000
12,000
39,000
NET CASH FLOW
-2,500
-2,000
3,000
-1,500
0
-2,500
-4,500
-2,500
-4,500
-1,500
Opening balance
Closing balance
Forecast is normally
produced by month
Net cash flow is the
difference each month
between cash inflows and
cash outflows
Opening balance is the
amount the business starts
with each month
Closing balance = opening
balance + net cash flow
Negative closing balance
suggests business needs
bank overdraft or additional
financing
Importance of good cash flow
forecasts
• The key to cash flow
management is having
good information
• A good cash flow
forecast:
– Is updated regularly
– Makes sensible
assumptions
– Allows for unexpected
changes
What is cash flow problem?
When a business
does not have
enough cash to
be able to pay
its liabilities
Common problems with cash flow
forecasts
• Sales prove lower than expected
– Easy to be over-optimistic about sales potential
– Market research may have gaps
• Customers do not pay up on time
– A notorious problem for small businesses
• Costs prove higher than expected
– Perhaps because purchase prices turn out higher
– Maybe also because the business is inefficient
• Certain costs are missed
– A common problem for a start-up
– Unexpected costs always arise – often significant
Responding to the limitations
• A good way is to create two different
versions of the cash flow forecast:
– A “base case” version which is the expected or
hoped-for version
– A “downside” or “worst case” version, which takes a
pessimistic view of what might happen
• Which forecast should be used?
– It depends on who is reading it.
– The bank manager is probably best given the
“downside” version so that his/her expectations are
managed
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