They say cash is king and that it's the life blood of a business, therefore being
able to accurately produce a cash flow forecast is an essential skill for
business people to be able to predict how much money their business expects to
receive in and payout over a given period of time. This video explains
cashflow forecasting and how to produce one for a business.
A cash flow forecast is a business tool which estimates how much money will be
coming into the business (which is known as cash inflow) and what money will be
going out of the business (which is known as cash outflows) over a set period of
time. Put simply, a cash flow forecast predicts the movement of money into and
out of a business's bank account. Once a business has conducted a cash flow
forecast, it provides them with something known as a cash balance. This is an
estimate of the bank balance at the end of each period calculated, which is
normally shown on a per month basis. Now a key term to remember when
conducting a cash flow forecast is net cash flow, this is the difference between
the cash inflows and the cash outflows. If the business's cash inflows are
greater than their cash outflows then they have a positive net cash flow which
is good for the business as they are predicting that they will have more
money coming in than they will need to pay out in the coming period. However if
their cash inflows are lower than their cash outflows they have a negative cash
flow, which means they are predicting they will pay out more money than what
they will receive in during that period of time and if the business has long
periods of negative net cash flow this may lead to financial difficulty and
closure of the business. Therefore, cash flow forecasting is a very important
tool for any business. Let's have a look at some other key reasons for businesses
to conduct a cash flow. forecast. First of all it helps to prevent insolvency, if
the business was to run out of cash it becomes insolvent which means that the
business can't pay its debts, meaning it is in danger of being closed down.
Therefore, being able to predict cash shortages provides the business with the
time to be proactive and resolve the situation before it arises. Another key
reason businesses use cash flow forecasting is to help them to obtain
external finance, for example if a business wanted to take out a bank loan
the bank is likely to want to see historical cash flows and future
forecasts before approving the finance. Being able to pay employees and
suppliers is absolutely crucial for any business, for example, imagine if you were
a supplier and a business didn't pay you for the stock you sold them, would you
supply them again? it's likely that you wouldn't. More importantly, if you were an
employee and didn't get paid imagine how you would feel?
You would be de-motivated at the very least but may also refuse to work or
leave the business completely. Therefore, by conducting a cash flow
forecast a business can be confident that they will have the sufficient cash
to ensure all payments are made on time or they can make arrangements to
generate more cash if this is required. A cash flow forecast also allows a
business to predict all of its income and expenses for a set period of time,
these can become targets for the business which they can then monitor and
compare their actual income and expenses against overtime allowing them to assess
their performance. Once the cash flow forecast has been completed it provides
a business with key information and data which the business can then use to
support its plans for the future, helping them to answer key questions such as;
should we employ a new member of staff and can we afford to? Should we expand
our business and open up a new store? and can we afford to reward our shareholders and
employees with a bonus next month. However it's very important to recognise
a cash flow forecast isn't an exact science and is in fact just a prediction of
what a business thinks will happen in the future, therefore it can be very
difficult to create an accurate cash flow forecast. So, the business owner
should use this as a guide rather than assuming that this is what will happen.
It is also more difficult for a new business to create a cash flow forecast
as they have no previous figures to help estimate these future cash inflows and
outflows, for example they don't know how well their product will sell or exactly
what their utility bills will be. At this point the business owner will have to
make predictions of what they think will happen and then monitor the business's
cash flow carefully over time to see whether their estimates were realistic,
they can then make changes if not. As the years go by and the business becomes
more established the owner can compare their actual cash flow against a cash
flow forecast to monitor whether it's achieving its targets and the cash flow
forecast should in theory become more accurate year on year. Just before we
look at an example of conducting a cash flow forecast, it's important to
understand where common cash inflows and cash outflows typically come from. Firstly,
we will look at some common cash inflows. Money from sales to customers is
a key cash inflow and one of the main reasons most businesses exist. Capital
from investors is another key cash inflow
whether this be the business
owner or minority shareholders. sourcing external finance is very common in
business, especially in the form of bank loans or business grants. However, it's
very important to acknowledge that a loan will need we paying and has interest
added which both act as a cash outflow later down the line.
Selling fixed assets that are no longer essential for the business is an
effective way of increasing cash inflows. This could be in the form of selling old
equipment such as a PC, a piece of machinery or even a van. If the business
has a spare office or warehouse space it can also increase its cash inflow by
renting this out. Now we'll move on to some cash outflows, one of the most
costly, yet important cash outflows for a business is paying their employees.
This tends to be one of the first expenses to get cut back through
redundancies when a business hits financial hardship To be able to sell
products or provide services the majority of businesses will have to
purchase materials or products from suppliers and once they have employees
and stock, a business will typically require somewhere to store, demonstrate
and sell the product from. Therefore, rent or mortgage payments are another common
cash outflow. Alongside the rent or mortgage payment, a business will also
have to pay utility bills such as the water, the gas and the electric and then on
top of all these utility bills, you've also got insurance.
As you can tell it's quite easy for a business's cash outflows to increase
rapidly once all these little expenses are added up. And one final common cash
outflow is the repayment and the interest paid on loans. Please be aware that
the cash inflows and outflows discussed are just common examples and the actual
amount and the types of cash inflows and cash outflows will actually vary from
business to business. To effectively conduct a cash flow forecast, it is
important to understand some key terminology and calculations. The opening
balance refers to the bank balance at the start of the period and should also
match the closing balance from the previous period, essentially whatever
balance your close a period with, this is the same amount that you must open up
with for the next period. The total inflow refers to all of the money that
has come into the business that month including the sales, loans or rental
income etc and is calculated by adding all of the cash inflows together. The
total outflows refers to all of the money that has gone out of the business that
month, this includes employee wages, utility bills and any purchases etc and this is
calculated by adding up all of the cash outflows together. The net cash flow is a
very important figure, this is the difference between all of the money that
the business had coming in during the period against everything that they have
paid out, it is this figure that determines whether the bank balance will
increase at the end of the period or decrease in comparison to what the
business opened with. This is calculated by deducting the cash outflows from the
cash inflows. The closing balance is the final key piece of terminology to discuss,
this is the actual cash that the business is left with at the end of the
period, it is calculated by adding the net cash flow to the opening balance.
However, if the net cash flow is negative you would actually deduct this figure
from the opening balance . So now you know the key terminology and calculations,
let's have a look at an example of cash flow forecasting.
So, the cash flow forecast we are going to work through is for a three month
period between April, May and June. Let's imagine this is our business and we are
now in March trying to predict what our cash flow is going to look like over the
next three months. So at the start of April we start with an opening balance of £1200.
We then move on to cash inflows which are going to be the sales and rent
of an office space for the next three months. We receive sales income of £6000
and rental income of £750, now we can
calculate our total inflows, which is all of our inflows added together which in
this case is sales and rent therefore the total inflow for April is £6750
Now we can move on to the cash outflows
which we are currently paying for wages, raw materials, marketing, rent and the
repayment of a loan and you'll see all of those listed on the first column on
the left hand side. Wages for April cost £1800 and
the payments for raw materials total £1200 now the following three payments are
fixed within which we pay the same amount every month regardless of how the
business performs so we pay £125 for marketing
every single month and our rent costs us £1400
finally our loan repayment is £100
By adding all of these together we can calculate our total
outflow for April which totals tells £4625
now we have calculated our total inflows and total outflows for April we
can now calculate our net cash flow for April, so the total inflows of £6750
- total outflows of £4625
equals a net cash flow of £2125
finally we can calculate our closing
balance for April which is our opening balance of £1200 pound plus net cash
flow of £2125 giving us a closing balance of £3325
for April essentially we start the month with £1200
and finish it a couple of thousand pound better off
that has been a successful month in April. Now that we've worked through the
month of April together I have put all of the inflows and outflows for our
business on your screen for both May and June, what I'd like you to do now is
pause your screen and try and calculate the opening balance, the total inflows
and outflows, the net cash flow and the closing balance for May and June. I will
then show you the correct answers when you restart the video.
you've got the figures on your screen so all you need to do is put an answer in
every single box that's got a dark blue shading.
okay so I hope that went well and you've managed to get an answer for every
single space, if you've got any questions or you need something clarifying as to
why it's an answer when we go through it please comment below and I'll be sure to
get back to as quick as I can to put a rational explanation behind the answer
so the golden rule is the opening balance is always the same as the
previous month's closing balance which in this case was £3325
all of the inflows added up to equal £5250 for May
and the total outflows add up to £4225
When we deduct our total outflows from our
total inflows it gives us a net cash flow of £1025
which is then added to our opening balance of £3325 to give us a
closing balance in May of £4350
therefore this is what we open with in June. Our total inflows for June equal
£4250 and our total outflows equal £4325
so now we can deduct our total outflows from our total inflows to give us a net
cash flow of minus £75 which means we are actually predicting
to operate at a loss in June, this is something that we should certainly
investigate to see if we can spot any reasons for this potential loss and
develop any solutions before it happens in reality. In this example our total
outflow stay pretty consistent across the three month period, however it is our
sales that have decreased and caused a negative cash flow in June
therefore we should now investigate potential solutions to increase sales in
the month of June which could be through a promotion etc. as we have a negative
net cash flow this is actually deducted from the opening balance to give us a
closing balance of $4275 at the end of June.
I hope this video has been a helpful introduction to cash flow forecasting
and if it has remember to give the video a
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activity worksheet in the description of this video if you would like to test
your knowledge. Thanks for listening and all the best.