The reality of developing a cash flow forecast is more complicated than theory books make it out to be; however, adopting a few practical strategies can bring you closer to developing a useable cash-flow forecast for your business.
Creating a cash-flow template
The first step to putting the pieces of this puzzle together is to create a cash-flow template. In a new spreadsheet, insert headings for the different months of the year along the top row. Down the first column, list the income and the expenses, so it roughly looks like a profit and loss statement split out over 12 months. If you want to step it up a notch you could invest in cash-flow forecasting software such as Calxa, which integrates with Xero, MYOB, and QuickBooks, and prepare your cash flow within the program.
Isolate elements of your cash flow that are constant, such as filing fees, bank charges, regular income and payments, outstanding accounts receivable and accounts payable, etc. and slot these predictable elements into your cash-flow template.
Patterns and causes
Identify what you think the causes of the unpredictable nature of other elements of the cash flow are; weather, periodic variations, interest rates, exchange rates, CPI etc. Establish all you know about these causes.
Look at past trends, to see if you can identify patterns that can apply in the future. For example, for every $1 spent on business marketing, sales increase by $5. Or December invoices are paid significantly later than average.
Look at the volatile elements of your cash flow and tag the elements using the following labels: seasonal, the lumpy-chunky rollercoaster, growing, and shrinking, or create your own relevant labels. Use the labels to sort and group the elements together, according to the labels you applied.
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With your insights into the causes of their unpredictable nature, determine how unpredictable you consider them to be. Of course you don’t have a crystal ball, so you can’t determine the absolute correct answer; instead what you need to do is apply
- Best case
- Most likely
- Worst case
scenarios and work within the spectrum of the results.
Let’s look at an example: A business sells Ugg boots, which the owner has labelled as a seasonal product. During spring and summer he believes sales will be low – between 50 and 150 pairs per month. During autumn and winter sales are predicted to be between 500 and 800 pairs per month. So a best-case-scenario cash flow has the Ugg boots selling at 150 pairs per month in the warm months, and 800 pairs per month in the winter months, while a worst-case scenario has boots selling at 50 and 500, and the most-likely scenario lies somewhere in between.
An extra dimension to complicate these scenarios is that the direct cost of the Ugg boots may be affected purchased in larger amounts, so if the client sells more they may indeed generate a higher gross profit.
Generate best- and worst-case scenario predictions for each month in your cash-flow template, so you effectively end up with two cash flows, and hopefully the actual result ends up somewhere in between. To assist in easily reading the information you might like to colour code the data: Best (green) and Worst (red).
Doing this exercise assists you in preparing for demands on your business cash and financing. Updating your forecast periodically, say every three months, assists you in understanding what is really happening, and what factors are really driving your business.
What are your tips for forecasting unpredictable cash flow?