How to Set Up a Cash Flow Forecast in 2021
Do you have one or more of these questions on your mind?
Are you worried about a dip in sales and how it will affect your ability to pay bills on time?
Can you afford to hire an extra pair of hands?
If you could go on a holiday in six months, without worrying about whether you will be covered to pay the bills on time?
If yes, you are in the right place because I am sharing below how you can have clarity and control of the cash flow and answer all these questions.
Every year in December, I do a reflection exercise with all my clients. I get them to reflect on the last calendar year and do a yearly forecast based on the previous few months’ business conditions.
We build three scenarios: the worst, most likely, and best-case scenarios.
It gives my clients cash flow clarity and allows them to check how far they are from where they are right now to where they want to be by the end of next year. This clarity leads to sound financial decisions and instills financial discipline in them.
To help you do the same, I will walk you through the process of setting up a cash flow forecast.
The process is the same whether you are doing 5, 6, 7, or 8 figures in revenue.
Let’s start by understanding the basics.
What Is a Cash Flow Forecast?
Just like you hear the weather forecast, whether it will rain? What is the temperature going to be etc.?
You also do a cash flow forecast to have an educated guess of how much cash will come, how much cash will go out, and what the cash position in the future looks like today?
How Does the Cash Flow Forecast Help You in Business?
Wouldn’t it be better if you know what’s most likely going to happen in the future, today itself so that you can make changes accordingly?
If you know it will rain heavily in two weeks; you will postpone your outdoor activities. Right?
And, it is much better than finding out on that day itself about bad weather.
In the same way, if you have information about the future cash flow position today, you can decide whether to change course or keep doing what you are doing.
So, if the outlook is positive, you will continue to do the things you are doing. And if it is negative, you would make changes to be on a positive cash flow trajectory.
E.g., if you are a creative marketing coach running masterminds.
And if the cash flow forecast suggests that masterminds won’t generate enough cash flow and coaching will bring in more cash flow and have a more positive cash flow impact, what would you do?
Would you continue to run masterminds or focus more on coaching?
To ensure that your cash flows are healthy, you’ll focus more on coaching.
What Are the Common Mistakes, When It Comes to Preparing a Cash Flow Forecast?
One of the most common mistakes entrepreneurs make is to run their business based on their bank balance and gut instincts. It’s okay when the business is small.
But as it grows and the numbers start to get bigger, it quickly goes out of hand.
This is a classic case of cash flow mismanagement.
Unfortunately, most businesses suffer cash flow problems due to poor cash flow management.
They never prepare a cash statement, let alone a cash flow forecast.
They believe that the only way to solve all business problems is to make more sales.
It only works if the sales are consistently profitable and there is a process to collect the payments, which they aren’t always.
This leads to another big mistake. Which is not having a cash flow runway of 6 to 12 months.
As they don’t have cash flow runaway for a few good months, that’s why we see so many businesses struggle when they don’t have sales for a month or so.
The Steps to Prepare a Cash Flow Forecast
I am sharing a simple five-step cash flow forecasting process with you that you can use to do your cash flow forecasting and reap all the benefits of doing it.
Step 1 | Bring Cash Flow Statement Up to Date As of December so That You Have the Data for the Last 12 Months’
These are actuals that happened for the whole year regarding cash receipts and cash payments and your cash balance as of 31 December.
Step 2 | Prepare Cash Flow Forecast Using This Template for the Next Three to Six Months
Copy and paste the same info from last year and save it as raw data to work on for this year.
Tweak cash receipts by an increment of percentage, reflecting the trading condition, which will impact costs of sales and expenses to run the business.
Watch this video, where I guide you on how to do it.
Step 3 | Check With Someone for a Sanity Check and Have Clear Communication
It’s a good idea to check with an expert as there will always be things you don’t know and can’t see. Rather than feeling sorry, it’s better to be safe.
Most people don’t even think about it. But, in my book, it should be essential. First, because you may not see what an expert’s eye can see, 1) because they have done it so many times, and 2) because you are too close to it and may miss out on essential details.
Step 4 | Make Changes to Your Business, According to What the Future Cash balance Looks Like
As you start to trade in the new year, and as the economic condition changes, people’s buying behavior also changes. So adjust your cash flow forecast accordingly.
Step 5 | Compare Each Month’s Actual Running Balance vs. Forecast and Make Changes Accordingly
As you update your forecast, compare what happened month by month with the forecast so that you can get better at forecasting.
That’s how you set up a cash flow forecast to make crucial financial decisions with facts and not based on the bank balance and gut instincts.
SUMMARY
In this section, we looked at how to set up a cash flow forecast to decide when you can afford to hire an extra pair of hands, pay yourself, etc. We also looked at common cash flow forecasting mistakes so that you can do it right.
