A few groundrules …
- Remember that forecasting is an approximation, so don’t try or expect perfection – an error tolerance of 5% to 10% is acceptable.
- Update your forecast regularly – we recommend weekly – that way it should never stray too far from the actual cash position.
- Be conservative – it’s best to underestimate your cash position and plan accordingly, rather than being overly optimistic.
- Remember its about real cash in your Bank account so be sure to exclude all non-cash items like depreciation and accruals.
- Also remember to test your cashflow assumptions against actual cashflows regularly.
Constructing the cashflow forecast
A cashflow forecast has two basic components – cash inflows and cash outflows. These are explained below.
The cashflow itself should be divided into weekly periods and extend for 6-12 months – beyond this period the forecast will likely become unreliable.
The overall structure, for each period, therefore is;
- Opening cash balance
- Add Sales / Other income
- Less Expenses
- Closing cash balance
- Inflows are primarily made up of trade sales and should be included when the cash is expected to be received (rather than the sale date). Take into account any trade discounts or rebates.
- Typically future sales are estimated using plan, budget or averages, however as mentioned its best to be conservative.
- Include investment income such as interest or dividends when usually received.
- Include any “one off” items such as loan drawdowns or equity injections.
- Start with regular cash expenses (including direct debited amounts) – these will include salaries and wages, rent, insurance, interest / lease obligations, contracted obligations and so on.
- Include taxation related costs – PAYG, Superannuation contributions and GST payments.
- Cost of sale items such as costs of manufacture, freight and logistics should be related to forecast sales – often a % is used eg freight costs at 10% of sales.
- If you are making purchases in foreign currency use the current spot exchange rate to convert to local currency.
- Include other trade payables when usually paid – often trade payables will be paid regularly weekly, fortnightly or monthly.
- Provide for unexpected expenses.
Once you have a reliable and accurate cashflow model make sure to identify any potential cash shortages and plan accordingly – ensure you have sources of cash available if needed.
Sources of cash can include an Invoice Discounting facility, a Bank Overdraft, Business Loan, Credit Card (not recommended) etc. Be aware however that establishing new lines of credit can be time consuming, so plan for a lead time if you don’t have an established source of cash to cover a potential shortfall.
That wasn’t too hard was it?