Making a profit is important, but having enough cash in the bank is what keeps a business running.
A business can be profitable on paper and still find itself short of cash. Customers might pay later than expected, a large VAT bill could fall due, or several major payments could leave the bank at the same time.
One of the best ways to avoid being caught out is to prepare a 13-week cash flow forecast.
A 13-week forecast gives you a week-by-week view of the money you expect to come into and leave your business over roughly the next three months. More importantly, it gives you time to act if you can see a cash shortage coming.
What is a 13-week cash flow forecast?
A 13-week cash flow forecast is simply a prediction of your business's cash position over the next 13 weeks.
You start with the money currently available in your bank account, add the cash you expect to receive, deduct the payments you expect to make, and calculate what's likely to be left.
The closing balance for one week then becomes the starting balance for the next.
Do this for 13 weeks and you have a rolling picture of where your cash position is heading.
The important thing to remember is that cash flow and profit aren't the same thing.
You might have made a £50,000 sale, for example, but if the customer isn't going to pay you for another 60 days, that money isn't available to pay this month's salaries or VAT bill.
Why use 13 weeks?
Thirteen weeks gives you roughly three months of visibility.
That's normally far enough ahead to identify potential problems, while still being close enough to make reasonably accurate assumptions about customer receipts, payroll, suppliers and tax payments.
It could help answer questions such as:
Will we have enough cash to pay salaries next month?
Can we afford to recruit another member of staff?
What will our bank balance look like when the next VAT payment is due?
Can we afford to buy that new piece of equipment?
Are customers paying us quickly enough?
Do we need additional working capital?
Instead of finding out there's a problem when the bank balance is already running low, you can potentially see it several weeks in advance.
And that gives you options.
How do you build a 13-week cash flow forecast?
The good news is that a cash flow forecast doesn't need to be complicated.
For many small and growing businesses, a properly constructed spreadsheet can be more than enough.
Here's where we'd start.
1. Start with what you've actually got in the bank
Begin with the current balance of your business bank accounts.
That gives you your starting cash position.
Don't use last month's management accounts or assume an unpaid customer invoice is effectively cash. Start with the money genuinely available to the business today.
2. Work out what customers are likely to pay you
Next, look at the cash you expect to receive over the next 13 weeks.
Your sales ledger and aged debtor report are good places to start, but don't simply assume every customer will pay on their due date.
Think about how customers actually behave.
If a customer's invoice falls due next Friday but they normally pay two weeks late, your forecast should take that into account.
This is where a good cash flow forecast can also highlight problems with credit control.
If a significant amount of your company's cash is regularly tied up in overdue invoices, improving the speed at which customers pay could make a substantial difference to your working capital.
3. Add your regular business expenses
Next, consider the payments that need to leave the business.
These could include:
rent
software subscriptions
utilities
insurance
marketing costs
professional fees
stock purchases
subcontractors
loan repayments
finance agreements
The important question isn't necessarily when the expense appears in your accounts. It's when the money will leave your bank account.
That's the date that matters for cash flow forecasting.
4. Include payroll costs
For many businesses, payroll is one of the largest monthly cash payments.
Make sure your forecast considers salaries and wages, along with the associated PAYE, National Insurance and pension contributions.
Remember that these amounts don't necessarily leave the bank on the same day.
If employees are paid at the end of the month but PAYE is paid to HMRC later, your forecast should show the cash leaving in the weeks it actually happens.
5. Don't forget the big tax payments
Tax is one of those areas that can easily create a cash flow shock.
Depending on your business, you'll need to think about payments such as:
VAT
PAYE and National Insurance
Corporation Tax
Construction Industry Scheme payments, where relevant
These payments can be substantial, so make sure they're included in the correct week.
A business might look comfortably cash-positive one week and considerably less comfortable once a large VAT or Corporation Tax payment has been made.
6. Include one-off expenditure
Not everything happens every month.
Perhaps you're planning to buy new computers, refurbish the office, make a large stock purchase, pay an annual insurance premium or put a deposit down on a new piece of equipment.
These one-off expenses should be included too.
If the timing isn't certain, you can also model different scenarios to understand the impact of making the payment sooner or later.
7. Calculate your expected closing balance
Once you've estimated the cash coming in and going out, calculate what's left at the end of each week.
For example, if you start the week with £50,000, expect to receive £20,000 from customers and expect £30,000 of payments to leave the account, your forecast closing balance would be £40,000.
That £40,000 then becomes your opening cash position for the following week.
Continue the calculation for the full 13 weeks.
You'll quickly start to see the weeks when cash is expected to be strong and, more importantly, where problems might appear.
Don't build it once and forget about it
This is where a 13-week cash flow forecast becomes genuinely useful.
It should be updated regularly.
At the end of each week, compare what you thought would happen with what actually happened.
Did that customer pay?
Was payroll as expected?
Was the supplier payment higher than forecast?
Did an unexpected cost appear?
You can then update the remaining weeks and add a new week to the end.
The result is a rolling 13-week cash flow forecast, so you're always looking approximately three months ahead.
Over time, it should also become more accurate as you better understand the cash patterns within your business.
What if the forecast shows you're going to run short of cash?
This is exactly why you're preparing the forecast.
Discovering today that you could have a cash shortfall in eight weeks is much better than discovering it when you've got eight days left.
Depending on the circumstances, you might have time to:
chase overdue customers
improve your credit control
ask customers for deposits or staged payments
negotiate payment terms with suppliers
delay non-essential expenditure
reconsider the timing of major purchases
reduce unnecessary costs
review stock levels
discuss an overdraft or working capital facility with your bank
The earlier you can identify the problem, the more options you're likely to have.
Test different scenarios
A good cash flow forecast isn't just about predicting what you think will happen.
It can also show you what could happen.
Try changing some of your assumptions.
What happens if your biggest customer pays four weeks late?
What if sales receipts are 20% lower than expected?
What if you recruit that new employee?
What happens if a major supplier increases its prices?
Can the business still comfortably meet its commitments?
This type of scenario planning can be extremely useful, particularly when you're considering making a significant business decision.
Watch your lowest cash point, not just the final figure
There's another important point to consider.
Your forecast might show that you've got £100,000 in the bank at the end of Week 13, which sounds great.
But what happened in between?
If the balance falls to £5,000 in Week 7 before recovering, that could be the number you really need to focus on.
That's why looking at your cash position week by week can be much more useful than simply looking at where you expect to end up in three months' time.
Cash flow forecasting is really about better decisions
The spreadsheet itself isn't the important part.
It's what you do with the information.
A good 13-week cash flow forecast can help you answer some of the biggest questions facing your business:
Can we afford to recruit?
Can we invest in new equipment?
Can we take more money out of the business?
Do we need more working capital?
Why are we making a profit but not seeing the cash in the bank?
Where is our cash actually going?
Once you can see what's likely to happen to your cash, you can start making decisions before problems occur rather than reacting to them afterwards.
Need a clearer picture of your business cash flow?
At Welf Accountants, we believe good financial information should help you run your business, not simply tell you what happened last year.
Cash flow forecasting, management accounts and budgeting can give you a much clearer picture of where your business is today and, more importantly, where it's heading.
If you're growing, experiencing cash flow pressure or simply want better visibility over your finances, get in touch with Welf Accountants to see how we can help.