Why You Need a Cash Flow Forecast For Your Small Business

Whether you’re running an e-commerce site in Dublin, managing a marketing agency in Cork, or launching an innovative startup in Galway, understanding and predicting your cash flow can make the difference between thriving and merely surviving.

At Around Finance, we’ve seen firsthand how proper cash flow management can transform businesses. That’s why we’re looking into the world of cash flow forecasting, with a special focus on the three-scenario approach: Baseline, Good, and Bad. This method isn’t just about numbers; it’s about preparing your business for whatever the future might hold.

What Is A Cash Flow Forecast?

It is a financial tool that projects a business’s future cash inflows and outflows over a specific period. This forecast helps you anticipate your cash position, manage liquidity, and plan for future financial needs. Basic cash flow projection includes:

Cash Inflows: These are the funds expected to be received by the business, such as sales revenue, receivables, loans, and investments.
Cash Outflows: These are the expenses and payments the business anticipates making, including salaries, rent, utilities, loan repayments, and other operational costs.

Cash flow projections can be short-term (weekly or monthly) or long-term (quarterly or annually), depending on the business’s needs. Regardless of the time frame, accurate forecasting is necessary for maintaining financial health and avoiding unexpected cash shortages.

Why Is A Cash Flow Forecast Important?

A forecast is more than just a financial tool; it’s a strategic compass. It’s helpful for:

Survival: It helps you identify potential cash shortages before they become crises. This allows you to take proactive measures to avoid running out of cash.
Decision Making: With a clear picture of your cash position, you can make informed decisions about investments, expenses, and financing.
Financing: Lenders and investors often need these forecasts to assess your business’s financial health and risk.
Planning and Budgeting: It is the foundation for effective budgeting and financial planning.
Risk Management: By identifying potential cash flow challenges, you can develop contingency plans to reduce risks.

What Is A Cash Flow Forecast Used For?

Forecasts are crucial for budgeting, financial planning, working capital management, evaluating business opportunities, preparing for seasonal fluctuations, and demonstrating financial stability to stakeholders. They help allocate resources efficiently, manage working capital, evaluate business opportunities, prepare for seasonal fluctuations, and demonstrate financial management skills to investors, lenders, and potential business partners. They also serve as a powerful tool for showcasing financial stability.

How To Forecast Future Cash Flows

A step-by-step guide to creating a forecast:

Set the Time Frame: Define the period for your forecast, whether it’s weekly, monthly, quarterly, or annually. The time frame will depend on your business’s needs and the level of detail you require.
Project Cash Inflows: Estimate all sources of income for the forecast period. This includes sales revenue, accounts receivable, loans, investments, and other income streams. Be realistic and conservative in your estimates.
Project Cash Outflows: List and estimate all expenses for the forecast period. This includes salaries, rent, utilities, loan repayments, and other operational costs. Review your historical expenses and adjust for any anticipated changes.
Calculate Net Cash Flow: Subtract total outflows from total inflows to determine your net cash flow for the forecast period. This figure represents the net amount of cash that will be added to or subtracted from your cash reserves.
Create Multiple Scenarios: Develop baseline, good, and bad scenarios to anticipate different outcomes. This helps you prepare for various financial situations and make informed decisions based on different possibilities.
Review and Adjust: Regularly review and adjust your forecast based on actual performance and changing conditions. This guarantees that your forecast remains accurate and relevant, allowing you to respond to changes in your business environment effectively.

The Three-Scenario Approach to Cash Flow Forecasting

Let’s look into the process of creating a forecast.

Baseline Forecast

The baseline scenario represents your best estimate of what’s most likely to happen. It’s grounded in realistic expectations based on historical data and current market conditions.

What to Include

Projected sales based on current trends and confirmed orders
Regular operating expenses
Planned investments or expansions
Known upcoming changes (e.g., price increases, new hires)

How to Calculate
Start with your historical data and adjust for any known changes or reasonable expectations. This scenario should feel achievable without being overly optimistic or pessimistic.

Good Forecast

The good scenario explores what might happen if things go better than expected. While it should be positive, it should still be within the realm of possibility.

What to Include

Higher sales projections (e.g., winning a big contract or successful product launch)
Potential cost savings or efficiencies
Faster payment from customers
Favourable market conditions

How to Calculate
Take your baseline scenario and adjust key variables positively. For example, you might increase sales by 10-20% or reduce certain expenses. Be sure to consider the knock-on effects of these changes (e.g., higher sales might require more inventory).

Bad Forecast

The bad scenario helps you prepare for potential difficulties. It’s about being ready for setbacks.

What to Include

Lower sales projections
Delayed payments from customers
Unexpected expenses or price increases from suppliers
Potential economic downturns or market challenges

How to Calculate
Again, start with your baseline and adjust key variables negatively. You might reduce sales by 10-20%, extend customer payment terms, or include contingencies for unexpected costs.

Benefits Of Using Multiple Scenarios In Forecasting

Improved Decision-Making: By considering different outcomes, you can make more informed decisions and develop contingency plans.
Risk Management: The bad scenario helps you identify potential risks and prepare mitigation strategies.
Opportunity Identification: The good scenario can highlight potential areas for growth or investment.
Stakeholder Communication: Multiple scenarios provide a more comprehensive view of your business’s potential, which can be valuable in discussions with investors or lenders.

Tools And Software For Cash Flow Forecasting

Excel Spreadsheets: Versatile tool for cash flow projection, allowing customisation and manual data input.
Accounting Software: Includes built-in features like QuickBooks, Xero, and Sage for accurate forecasting.
Specialised Forecasting Tools: Float, Fathom, and Spotlight Reporting offer advanced features like scenario planning, real-time data integration, and visual dashboards.

Forecasting For Different Business Types

While the principles of forecasting apply broadly, different types of businesses may need to focus on specific aspects:

Startups and Early-Stage Businesses

- Focus on runway (how long current cash will last)
- Model different growth scenarios
- Consider multiple funding rounds

Established SMEs

- Pay attention to working capital management
- Factor in potential for expansion or diversification
- Consider impact of market changes on established product lines

Seasonal Businesses

- Model cash flow on a monthly or even weekly basis
- Plan for off-season cash requirements
- Consider weather-related contingencies

Service-Based vs. Product-Based Businesses

- Service businesses may focus more on billable hours and project timelines
- Product businesses need to factor in inventory management and supply chain considerations

Remember, the goal isn’t to predict the future with perfect accuracy. Instead, it’s about being prepared for different possibilities and having a plan for each. By embracing this approach, you’re not just managing your finances, you’re strategically positioning your business for success. Contact Around Finance today for a consultation.