Forecasting Cash Flows Forecasting Cash Flows

Cash flow is important Cash flow is a dynamic and unpredictable part of life for a start-up or small business Cash flow problems are the main reason why a new business fails Regular and reliable cash flow forecasting can address many of the problems

Main kinds of cash flow Cash is needed for… Setting the business up Day-to-day trading Growth Cash inflowsCash outflows Cash salesPayments to suppliers Receipts from trade debtorsWages and salaries Sale of fixed assetsPayments for fixed assets Interest on bank balancesTax on profits GrantsInterest on loans & overdrafts Loans from bank Dividends paid to shareholders Share capital investedRepayment of loans

Why cash flow forecasting is important Cash is king – it is the lifeblood of a business If a business runs out of cash it will almost certainly fail Few start-ups have unlimited finance – cash is limited, so it needs to be managed carefully

Why produce a cash flow forecast? Advanced warning of cash shortages Make sure that the business can afford to pay suppliers and employees Spot problems with customer payments As an important part of financial control Provide reassurance to investors and lenders that the business is being managed properly

Why start-ups suffer from cash flow problems It can be a while before the business makes its first sales – the pre-trading period often involves incurring costs without getting any revenue in return Suppliers may demand immediate or early payment because business does not have a track record for paying bills on time A new business usually has to spend up-front on expenses such as marketing and product development The new business will not have reserves of cash built up from profitable trading (“retained profits”)

Sources of information for a cash flow forecast Entrepreneur experience – Industry experience can prove vital – Otherwise forecast has to include “gut feel” assumptions (dangerous) Market research – A crucial role – typical payment terms for customers, suppliers – Reflect seasonal peaks and troughs in demand – Helps identify potential costs Suppliers – Very useful source of industry information Advisers (e.g. accountant, bank manager) – Great for helping put the forecast together – Can challenge the assumptions made – Can check that the forecast is complete and accurate

What the cash flow forecast contains Cash inflows (into the business) – Movements of cash into the bank – Receipts from customers – Investment by the entrepreneur – Loans from the bank or others Cash outflows (out of the business) – Payments to suppliers (materials, equipment, premises) – Payments to employees (wages & salaries) – Payments to lenders (e.g. interest, loan repayments) – Payments to shareholders (dividends)

Cash flow forecast - illustrated JanFebMarTotal CASH INFLOWS Investment10,000 Sales2,50010,00015,00027,500 Total inflows12,50010,00015,00037,500 CASH OUTFLOWS Raw materials4,0005,000 14,000 Wages & salaries3,5004,000 11,500 Marketing2,5001,0002,0005,500 Set-up costs3,0001,00004,000 Other costs2,0001,000 4,000 Total outflows15,00012,000 39,000 NET CASH FLOW-2,500-2,0003,000-1,500 Opening balance0-2,500-4,500 Closing balance-2,500-4,500-1,500 Forecast is normally produced by month Net cash flow is the difference each month between cash inflows and cash outflows Opening balance is the amount the business starts with each month Closing balance = opening balance + net cash flow Negative closing balance suggests business needs bank overdraft or additional financing Closing balance = opening balance + net cash flow Negative closing balance suggests business needs bank overdraft or additional financing

Importance of good cash flow forecasts The key to cash flow management is having good information A good cash flow forecast: – Is updated regularly – Makes sensible assumptions – Allows for unexpected changes

What is cash flow problem? When a business does not have enough cash to be able to pay its liabilities

Common problems with cash flow forecasts Sales prove lower than expected – Easy to be over-optimistic about sales potential – Market research may have gaps Customers do not pay up on time – A notorious problem for small businesses Costs prove higher than expected – Perhaps because purchase prices turn out higher – Maybe also because the business is inefficient Certain costs are missed – A common problem for a start-up – Unexpected costs always arise – often significant

Responding to the limitations A good way is to create two different versions of the cash flow forecast: – A “base case” version which is the expected or hoped-for version – A “downside” or “worst case” version, which takes a pessimistic view of what might happen Which forecast should be used? – It depends on who is reading it. – The bank manager is probably best given the “downside” version so that his/her expectations are managed

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