How To Build a Cash Flow Forecast (And Improve Your Cash Flow at the Same Time)

The problem

The problems created by not knowing what your next twelve months of cash flow could like are endless. Employees know what they are going to be earning, so why shouldn’t a business owner?

Without knowing your cash flow, you can’t accurately determine how much you can safely withdraw from the business to pay yourself. This prevents you from setting earnings goals.

Furthermore, the family suffers as you can’t really budget for their needs either.

It’s easy to fall into this trap of notknowingness.

Often times, directors don’t have the correct foundation in place which allows them to understand their cash flow.

Business bank accounts aren’t set up correctly.

The Solution

Accounts should be set up so that income tax and GST can be siphoned off on a regular basis, leaving actual business cash in the main trading bank account.

Without this setup, it’s easy for directors to use the trading account as a piggy bank and just take funds out because ‘there’s money in the bank’.

“Split your income tax and GST out, and you are on your way to cash flow success.”

It’s also important to get into a regular habit of keeping tabs on your profit and loss. Most directors would be doing so already, but if you’re not, this is a fundamental step to knowing what you’re earning and what cash you are bringing in. Do this regularly – weekly or monthly. Try and line the frequency up with when you pay yourself.

This leads me to my next point; profit does not equal cash. Once you’re in the habit of checking your profit and loss regularly, you’ll start to notice that what you have earned in net profit for the period does not tie up with what’s in the bank. You may have earned $30k for the month, but only have $20k in the bank.

This is all down to your debtors and creditors. Otherwise known as Accounts Receivable and Accounts Payable.

If you have made a sale, but have not been paid for it yet, the sale will still show on your profit and loss, but your bank account will still be without. Hence, it’s important to understand what you are owed before you decide to pay yourself.

Having a regular follow-up process with customers to chase unpaid invoices will help if you find your accounts receivable growing. Change your payment terms; 50% deposit upfront with the balance on completion, or switch to a pay monthly subscription model.  

You can also turn invoice reminders on in your accounting software. This sends the customer a reminder that the invoice is overdue, on a customizable frequency; a week, month or whatever you choose, past the due date. Pay your creditors as late as possible and extend the as agreed payment terms you have with them. Ensure you are paying the right amount of tax; minimizing expenditure, over the medium term, increases cash flow.

Building the forecast (and free forecast template)

Building a cash flow forecast goes a long way to helping you understand your cash flow. Creating good habits is always good, right?

You can use either excel or google sheets for this. I steer away from cash flow software as I find it doesn’t allow you to understand the building blocks of the forecast, and are generally annoying to use, frankly. Note all figures in the forecast need to be on a GST exclusive basis.

Step 1. Determine what time period you are going to be working with; weekly, or monthly. I recommend monthly. This is granular enough. Weekly can get messy.

Step 2. We need to know what is coming into the business in the form of sales. Break it down into tiny pieces. If your business earns on an hourly basis, determine the hourly rate, and how many hours are worked each month. For one person it could be 8 hours a day for 20 working days in a month = 160 hours. Multiply your hourly rate by the hours worked and you have your revenue forecast.

Note that because we are breaking things down, it’s easier to modify the figures on a month-to-month basis and get things more accurate. For instance, if your winters are quieter, you can reduce your hours to say 6 per day.

It’s really easy to just drag a cell across each month in your spreadsheet, saving you from entering the data month by month.

Step 3. What does each sale cost you? As with revenue, we break this down into pieces. If you are charging staff out, put down what you are paying them (your cost) and how many hours they work. If they work 6 hours a day, 5 days a week, that equates to 120 hours a month.

If you are selling widgets, this can be broken down into how many units sold per month, and the cost of each unit.

Once these two sections are complete, you can calculate your gross profit. Deduct your total cost of sales from total revenue. For April in the example, this would be $48,000 less $3,600 equals $44,000. Gross profit is important as this is the figure you feel you have ‘earned’ on the ground after making a sale. We are now putting it on paper. This is also the figure you have available to spend on your overheads, including your own wage.

Step 4. Overheads. The fixed costs of running your business.

These are normally straightforward to work out as they generally don’t change much month-to-month. I usually just take last month's figure and adjust up or down to arrive at an amount that ‘feels’ correct. This can always be adjusted in time if you feel the figures are out of whack. So, run a profit and loss report for the last month and you should have your numbers. Enter these into the first month of your forecast and drag across to the last month.

After deducting total overheads from gross profit, we are left with net profit. Next, we deduct tax at our marginal tax rate (the highest tax rate applicable to you – if you’re earning above $180k, then this will be 39%). If you’ve already siphoned the tax away into a separate tax savings bank account, you can skip this step.

Step 5. You are then left with your net profit after tax.

Now, if you don’t have any accounts receivable, this is the figure you can withdraw from the company bank account to pay yourself.

If you do have accounts receivable, then you need to deduct the accounts receivable figure for the month and you will end up with your monthly cash profit. Note that accounts receivable is represented as a balance in your accounting software. So, you’ll need to calculate the accounts receivable for the month in question. Take the opening balance at the beginning of the month and deduct the closing balance at the end of the month.

If you’d like a copy of the cash flow forecast spreadsheet featured in the examples above, you can do so for free here (you’ll need to make a copy of the sheet before you can edit it).

Happy cash flows 😁