A Step-By-Step Guide to Cash Flow Forecasting

I'm super manIn my last article, I discussed the excuses I often hear for not preparing a forecasted cash flow.  Hopefully, the reasons I identified for developing one were compelling enough for you to ask “so how do I prepare a forecasted cash flow?”  The short answer is: with lots of input from your team.

This is perhaps the biggest reason most accountants are not able to prepare a meaningful cash flow forecast.  It requires input from a number of people in your organization and a thought process very different from keeping the books.  Everyday cash is flowing through your organization….money in / money out. In most organizations without a CFO, there is no one person responsible or able to identify this money flow.  So back to the question . . .

How Do I Prepare a Forecasted Cash Flow?

When working with companies, I begin by keeping the initial forecast very simple and then develop detail calculations over time.  Cash is either coming in, “Source” or flowing out, “Use”.

My starting point is to review the current financial statements and operating budgets.  Most of the time with small businesses, the forecasted cash flow has not been developed because the operating budgets are non-existent. I start with identifying all the “sources” of cash.  Typically, these sources are easily identified because there are only a handful of them:

  • Sales
  • Deposits
  • Collections of accounts receivables
  • Note receivable payments
  • Capital injections
  • Loan proceeds

I always start with a sales projection review to ensure it’s realistic, and then ask the question: “how and when is the sale converted to cash?”

  • Is cash received at time of sale or is there a timing difference? Even with e-commerce sales there is a 2-3 day timing difference plus payment of the merchant account fees before cash is received.
  • If you sell on account, how long does it take on the average to collect? Again we need to understand the timing of when cash is received.
  • What percent of our receivables are never collected? Typically, developing a spreadsheet for forecasting the time of cash from sales is the most challenging and the most important because it is our main source of cash flow.

If you don’t understand how cash flows from sales, then forecasting is very difficult.  I will similarly go through all the other sources of cash and understand the timing of receipt of each one.

To forecast the “Use” side, the best place to start is with a review of the Income Statement, beginning with the Cost of Goods Sold section.  If it’s a product based business I will ask questions until I understand how inventory is purchased, processed and delivered.  Similar to sales, this is typically the most challenging area, yet most important because it’s typically the largest use of cash in the business.  If it is a service business, then understanding the timing of payments to employees and subcontractors is critical.

Many times in service businesses the owners are surprised by the amount of cash they have expended before they receive payments from sales.  When preparing the forecasted cash flow the first time, there is almost always a change in how the business operates in the future (from a cash flow perspective) because of the insights obtained by understanding how cash flows in and out of their business.  After the Cost of Goods Sold, I review each operating expense as to the timing of the expense.  The next step is to review the Balance Sheet – both assets and liabilities – to determine if there are additional cash outlays in the future.  For example: purchase of fixed assets, sales of fixed assets, payment of accounts payables, credit card payment, loan payments, dividends or distributions to owners.

When I prepare a forecasted cash flow, I like having a summary sheet (here’s an example) with a detail sheet for each Source and Use line.  It makes the summary easier to read and provides space in the detail to document my assumptions.  The last section of the forecasted cash flow provides a running balance of the projected cash balance based on these set of assumptions.  While I know that this will never be 100% accurate, I can review the projected cash balance to determine if there is a projected shortfall in the future.  Knowing this information now allows the business to take action to mitigate the shortfall.  I ran my own business for many years forecasting shortfalls, but with the cash flow forecast I was able to communicate to my team where our focus needed to be.  As you know, cash is the fuel for your business…you can’t operate without it!

I’ve been asked a number of times “how often should I prepare my forecasted cash flow?” The answer is based on what the current cash flow is telling you.  If cash is tight and there are projected shortfalls, I like to see a 6 week cash flow by day prepared weekly.  In any case, I like to see a 3 month cash flow by week prepared monthly.  And, of course, a 12 month cash flow forecast prepared as part of the annual operating budget.

There’s certainly a lot to know when it comes to forecasting cash flow, but once you have the recipe down, it is an invaluable tool, and something you’ll wonder how you ever operated without. Still have questions? I make myself available for complimentary consultations and would be happy to help you uncover the answers. Give me a call or send me an email to get the conversation going.

Rick Arthur

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Rick Arthur is a CFO whose expertise is built on Financial Intelligence and 35 years in senior financial roles. Coupled with a CEO’s perspective and the experience of building his own $20 million company, he brings a unique depth of insight into business from the top down. Wired to get to know people, Rick works hand-in-hand with business owners of intentional, growth-oriented companies, solidifying relationships as a trusted advisor and confidant to his clients. He leverages his experience to help business owners gain traction and stay laser-focused on the company’s vision, cash flow, and profitability – all while creating big picture solutions for strategic planning, growth and sustainable success.