Cash Flow Forecasting

STARTER Think about the bill payer in your household. What things need to be paid each month? How are those bills paid for?

What this topic is all about Cash flow is a dynamic and unpredictable part of life for a start-up Cash flow problems are the main reason why a new business fails Cash flow forecasting looks at why and how a start-up should prepare regular forecasts

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

Cash flow forecast - illustrated Forecast is normally produced by month Jan Feb Mar Total CASH INFLOWS Investment 10,000 Sales 2,500 15,000 27,500 Total inflows 12,500 37,500 CASH OUTFLOWS Raw materials 4,000 5,000 14,000 Wages & salaries 3,500 11,500 Marketing 1,000 2,000 5,500 Set-up costs 3,000 Other costs Total outflows 12,000 39,000 NET CASH FLOW -2,500 -2,000 -1,500 Opening balance -4,500 Closing balance NET CASH FLOW= CASH INFLOWS MINUS CASH OUTFLOWS Opening balance is the amount the business starts with each month CLOSING BALANCE= OPENING BALANCE PLUS NET CASH FLOW

Reasons to produce a cash flow forecast Identify potential shortfalls in cash balances in advance (important) 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 are vulnerable to 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 from the start-up as the business has not developed 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 – an important source of cash known as “retained profits”

Sources of information for a cash flow forecast Entrepreneur experience Industry experience can prove vital Otherwise, it 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 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)

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 The cost of production proves higher than expected Perhaps because purchase prices turn out higher Maybe also because the business is inefficient Certain costs are not included A common problem for a start-up Unexpected costs always arise – often significant

Improving the Cash Flow Arrange an Overdraft Buy and hold fewer stocks (eg. Just in Time – JIT) Credit Control – allow customers less time to settle their bills Spread large payments over a longer period of time Selling Assets (eg. Machinery or other equipment) Extend Trade credit from suppliers