Aisha supplies stationery to offices. Her sales are growing every month, her income statement shows a profit, and by the end of March her bank account is overdrawn.
Nothing went wrong in her business. She simply made the sales in one month and received the money two months later, while her suppliers, her rent and her staff wanted paying straight away. A cash flow forecast would have shown her the problem in January.
A cash flow forecast is a month-by-month list of the cash you expect to receive and the cash you expect to pay. It tells you what your bank balance will be at the end of each month, so you can see a shortfall before it arrives and do something about it while you still have choices.
Profit and cash are not the same thing
Profit counts a sale when you make it. Cash counts it when the customer pays. Profit spreads a new machine over its useful life. Cash takes the whole amount out on the day you buy it. Profit ignores the money you take out for yourself and the loan instalments you repay. Your bank account does not.
So a business can be profitable and short of cash at the same time. It happens most often to businesses that are growing, because every new sale on credit needs stock and wages paid now, and the money for it comes in later.
A worked example: three months of Aisha’s business
Here are Aisha’s figures for the first quarter:
- Cash in the bank on 1 January: $5,000
- Sales: $10,000 in January, $12,000 in February, $15,000 in March. Sales in November and December were $8,000 each.
- Her customers pay 60 days after delivery, so January’s cash comes from November’s sales.
- Stock costs 60% of the selling price, and she pays her suppliers in the same month.
- Rent is $1,500 a month and wages are $2,000 a month.
First, her profit:
| January | February | March | |
|---|---|---|---|
| Sales | 10,000 | 12,000 | 15,000 |
| Cost of stock (60%) | (6,000) | (7,200) | (9,000) |
| Rent and wages | (3,500) | (3,500) | (3,500) |
| Profit | 500 | 1,300 | 2,500 |
$4,300 of profit in three months, and rising every month. Now her cash:
| January | February | March | |
|---|---|---|---|
| Opening cash | 5,000 | 3,500 | 800 |
| Cash from customers | 8,000 | 8,000 | 10,000 |
| Paid to suppliers | (6,000) | (7,200) | (9,000) |
| Rent and wages | (3,500) | (3,500) | (3,500) |
| Closing cash | 3,500 | 800 | (1,700) |
Profit went up by $4,300. Cash went down by $6,700. The difference is money her customers owe her for February and March sales, which will not arrive until April and May.
Without a forecast, Aisha finds out at the end of March, when a supplier payment bounces. With one, she sees it in January and has two months to act.
How to build your own forecast in five steps
1. Start with today’s bank balance
Use the real figure from your bank, not the figure in your books. Add any cash you keep in the business.
2. List the cash coming in, in the month it will arrive
Cash sales go in the month you make them. Credit sales go in the month customers actually pay, not the month on the invoice. If customers are often late, use the date they usually pay. Add any other money you expect: a loan, capital you plan to put in, the sale of an old vehicle.
3. List the cash going out, in the month it will leave
Suppliers, wages, rent, utilities and transport are the obvious ones. The ones people forget are the ones that cause trouble: annual licence fees, insurance, tax payments, equipment you plan to buy, loan repayments and the money you take out for yourself.
4. Work out the closing balance for each month
Opening cash, plus cash in, minus cash out, gives closing cash. That closing figure becomes next month’s opening cash. Carry it forward for at least three months, and ideally twelve.
5. Find your tightest month, then update every month
Look for the lowest closing balance. That is the month to plan for. At the end of each month, replace the forecast figures with what actually happened and roll the forecast one month further. A forecast you made in January and never touched again is a guess. One you update every month becomes a habit that protects the business.
What to do when the forecast shows a gap
The value of a forecast is the time it gives you. In Aisha’s case, the largest single fix is her credit terms. If her customers paid in 30 days instead of 60, the same sales would bring in $8,000 in January, $10,000 in February and $12,000 in March. Her bank balance would end the quarter at $2,300 instead of an overdraft of $1,700, without one extra sale.
Other things that help, roughly in order of how quickly they work:
- Chase what you are owed. Send invoices on the day you deliver, and follow up on the day payment is due, not a month later.
- Agree longer terms with suppliers. Ask before you need it. A supplier you have always paid on time will often agree to 30 or 45 days.
- Move spending that can wait. New equipment, a refit or extra stock can usually move to a month with more room.
- Take less out of the business for a few months. Owner drawings are often the easiest payment to reduce.
- Arrange extra funding early, if you need it. Money is far easier to arrange two months before a shortfall than two days before it, and you keep the freedom to choose finance that fits your principles.
Five mistakes that make a forecast useless
- Entering sales instead of receipts. The forecast then looks exactly like your profit, and hides the gap it was meant to show.
- Forgetting payments that come once or twice a year. They are small in the annual budget and large in the month they fall.
- Leaving out drawings and loan repayments, because they are not expenses in the income statement.
- Assuming customers pay on time when they usually do not.
- Building it once and never updating it.
The same discipline protects you in another way. When you know what the bank balance should be each month, money that goes missing is much easier to notice. If that worries you, read about the simple internal controls that protect a small business.
Make your own forecast now
You can build a forecast on paper or in a spreadsheet with the five steps above. If you would rather not start from a blank page, the free Cash Flow Forecast Calculator looks twelve months ahead. Enter where you are today and how your customers pay, and it shows your month-by-month balance.
If your cash is tight because your prices are too thin, start with the two-minute test of what one sale really pays you.
Want the full picture in one place?
The Small Business Cash & Profit Kit plans twelve months of your business in Excel or Google Sheets. It builds your profit and loss account, cash flow and balance sheet for every month, shows your tightest month before it arrives, and explains why your profit and cash differ.
Questions people ask
How far ahead should a cash flow forecast go?
Twelve months, month by month, is a good standard for most small businesses. If cash is already tight, also keep a week-by-week forecast for the next six to eight weeks.
What is the difference between a cash flow forecast and a cash flow statement?
A forecast looks forward and uses your best estimates. A statement of cash flows looks back and reports what actually happened in a past period. You use the forecast to make decisions and the statement to check them.
Do I include VAT or GST?
Yes, if you are registered. Include the tax in the amounts you receive and pay, and show the payment to the tax authority as a separate line in the month it is due.
How often should I update it?
Once a month at least. Replace last month’s estimates with the real figures, check where you were wrong and why, and add a new month at the end.
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