How to make a cash flow forecast

Chief Accountant Emily Coltman

About the author: Emily Coltman, FCA is the Chief Accountant for FreeAgent, who make online accounting software for small businesses and freelancers.

What is a cash flow forecast and why should I make one?

Financial forecasts aren't just for large multinational corporations. They are valuable for any business, and are perhaps even more important for small businesses, where a healthy cash flow is essential given they don’t always have as much cash available to draw on in case of an emergency.

A cash flow forecast can help you:

  • plan out how much you expect to make in sales this year
  • plan how much you expect to spend in costs
  • understand when cash will come into your bank account and leave it

Armed with this knowledge, you will be well placed to make important decisions about your business. Here are some questions that a cash flow forecast can help you answer:

  • Could you start making a new product, or offer a new service?
  • Could you start selling in a different country?
  • Can you afford to recruit a new member of staff?
  • Should you outsource some of your day-to-day tasks?
  • If you need more space for your business, can you afford to rent an office or workshop rather than working at home?
  • Are you at risk of running out of cash? Should you look at borrowing money?
  • When could you consider taking more money out of your business?

Forecasting: before you start

A financial forecast should be as comprehensive as you can make it, so you should try and remember to include all your sales, costs and cash transactions. However, your forecast doesn’t have to be penny-accurate and it also doesn’t have to be difficult to compile.

How far should I forecast into the future?

It’s up to you how far in advance you forecast, but bear in mind that the further in the future you try to look, the less likely it is that your forecast will be realistic. Nobody can predict what effect future changes to business rules and the global economy will have on your business - a good rule of thumb is to forecast one year ahead.

Remember that your forecast is not set in stone. You can - and should - change the figures in your forecast if you realise that your original plan is not coming to pass, for example if a new product sells better than you expected.

The ingredients of a cash flow forecast: sales, profit and loss, and cash flow

To build a cash flow forecast, we recommend creating three separate forecasts: sales, profit and loss, and cash flow. We’ve created a cash flow template with example data that you can follow along with as a guide. The template also includes a section for your own data.

Step 1 Create a sales forecast

The first forecast you should create is your sales forecast, because that’s the starting point of your profit and loss forecast, which will, in turn, help you create your cash flow forecast.

What is a sales forecast?

A sales forecast is a plan of how much you expect to sell in the future, normally broken down by month.

Checklist: filling in your sales forecast

Look at Sheet D in the cash flow forecast template. You’ll see that we’ve set up the template with a column for each month and a row for each product (or service) that you sell. We’ve also included a total column and total row. The total row is particularly important because it’ll feed across to your profit and loss forecast.

If you’re not sure where to start with predicting your future figures, here are a few pointers:

  • Look at your previous year’s sales figures. Are there any trends that you can see, and any seasonal variations in the figures? For example, if you sell phone covers, did your sales increase when a new model was released? If you sell handcrafted goods, did your sales increase in the run-up to Christmas?
  • Think about what new products you might like to sell, or new markets you want to try breaking into. How much do you expect to earn from them? Do your market research and try to predict their popularity. Remember, too, that you might have to take time away from existing products to develop, make and market new ones, or to research new markets, particularly overseas, so your sales of existing products may fall.
  • What is your ideal sales mix? Would you prefer to sell one product or service rather than another because it makes you a higher profit, or because you enjoy making or delivering it more? If you are aiming to make more sales in a particular area, build that into your forecast.
  • Are there any new contracts you are hoping to win? How likely is it that you will be awarded those contracts? Will working on these take time away from other work?

If your business is registered for sales tax, such as VAT, record your sales exclusive of this sales tax. That means that you shouldn’t include the tax in the forecast.

Let’s take an example of filling in the sales forecast.

Example of a sales forecast

Follow along in Sheet A of the cash flow template

Steve is an illustrator of children’s books. He works closely with an author, Rob, whose books he illustrates. Rob plans to write a new book early in 2015 so Steve expects to illustrate that.

He also expects to win a contract to draw an online comic strip series.

He carries out ad-hoc work illustrating greetings cards and would like to expand that side of his business. This work was particularly lucrative in the run-up to Christmas.

Steve plans his sales for 2015. He puts each of the three sales channels on one row of his spreadsheet. He records the sales when he expects to earn the money, not when he expects to be paid for his work - this is important because he will make his cash flow forecast later, and sales will form part of his profit and loss forecast, which needs to be drawn up on the basis of when he earns his money and when he incurs his costs. He is registered for sales tax, so he records his sales net of this tax.

He records his sales in round numbers, because this is a forecast rather than an exact prediction.

What Steve’s including in his forecast is his sales revenue (i.e how much he expects to earn from his sales). He can either plan how many units of product he expects to sell (i.e. illustrations), and multiply these by the expected price he expects to get for each unit, or he can think in terms of revenue only, rather than in terms of units sold (e.g. if Rob will pay him a total fee for the project rather than a fee per illustration).

Steve is confident that he will have enough time to carry out all this work, even at his busiest times.

Step 2 Creating a profit and loss forecast

Now that you’ve forecast your sales, it’s time to forecast your costs and pull the two together in a profit and loss account forecast.

What is a profit and loss forecast?

A profit and loss forecast is a forecast that combines the business’s income and its day-to-day running costs, giving you a view of your projected profit into the future.

Why a profit and loss forecast is useful

  • If you have an idea of how much profit you expect your business to make, then you’ll be able to estimate how much tax it will be liable for.
  • If you are planning changes in your sales, these will almost certainly affect your costs, either by increasing or reducing them. For example, if you want to start selling products overseas, there’ll be extra charges for shipping.
  • If you find you have to spend more, you could find yourself at increased risk of running out of cash. You may need to put your prices up or borrow some more money to mitigate this risk.

How to make a profit and loss forecast

Look at Sheet E of your cash flow template, called “Profit and Loss”. This is already set up with a column for each month. The first row of this will be for total sales, which should be automatically copied across from your sales forecast in Sheet D.

Checklist: costs to include in your forecast

With your sales totals in place, now add your business’s day-to-day running costs. These will be different for every business. We’ve included some typical costs in the template, but here are some pointers for costs to include:

  • If you make goods to sell, rather than services, you will have costs of sales, such as raw materials that you buy to make your goods. For example, a curtain-maker would have to buy fabric, tape and curtain rings. Adjust this figure to allow for stock you held at the start and end of the month. Add a row for gross profit, which is your sales minus cost of sales. Day-to-day running costs other than cost of sales are called “administration expenses”, or “overheads”.
  • Do you employ staff? If so, fill their wages into the “staff salaries” row. Don’t forget to add in any taxes you pay in addition to their wages, such as the UK’s employer’s National Insurance contributions.
  • How are your products or services reaching the customer? Include in your forecast costs such as delivery, packaging, printing of address labels, web hosting, and subscriptions for an online shop.
  • What software packages do you use in your business? Each individual package may be low-priced but all together the costs will mount up, so make sure you include them all. Include both monthly and annual subscriptions.
  • What professional services do you pay for? Remember to include accountants’ fees, solicitors’ fees, and fees for freelance contractors.
  • Do you use printed letterheads or business cards? Include the costs of having these printed.
  • Don’t forget an allowance for other stationery costs such as paper clips and Post-it notes.
  • What phone services do you use? Put in the costs of your landline and mobile phones, and the cost of any call answering services you use.
  • Do you buy office consumables, such as computer cables and batteries? If so, make sure you include these costs - if you’re not sure how much the items will cost, look at past receipts for a guide.
  • Don’t forget non-cash costs, such as depreciation of your assets, miles travelled in your own car, and business use of your home.
  • Include a row to sum the overheads, then work out your business’s net profit figure - this is the business’s sales less its total day-to-day running costs.

Things to remember when filling in your profit and loss forecast

Remember to include costs in the month that you incur them, rather than the month that you pay for them. Your cash flow forecast will be prepared on the basis of payment dates, but this profit and loss forecast must be prepared on the basis of when you incurred your costs.

If you are registered for sales tax, such as VAT, then include your costs exclusive of sales tax, unless you are using a scheme such as the UK’s VAT flat rate scheme where you report your costs inclusive of sales tax.

Keep in mind that you should only include your business’s day-to-day running costs in this sheet. One-off costs, such as buying a new computer, wouldn’t be included in your profit and loss forecast. That’s because you are planning how you expect your business’s profit and loss account to look, and that doesn’t include large one-off costs, which you’ll add to the next sheet instead.

Let’s look at how our illustrator Steve would fill in his profit and loss forecast.

Example of a profit and loss forecast

Follow along in Sheet B of the cash flow template

First, Steve pulls across his sales from his sales forecast.

His costs of sales would be his pens, rough sketch pads and drawing paper. The more cartoons Steve draws, the more of these items he will need, but in some of his quieter months he doesn’t expect to need to buy any more. He puts his best estimate of that cost into his profit and loss forecast.

Steve sends his cartoons to Rob electronically, which means that he won’t have costs of physical delivery for that project, and he expects to use the same delivery method for his new comic strip contract. However, he will need to post his greetings cards, so he will need to include the costs of delivery and packaging. These will vary with how many cards he sells, so he refers back to his sales forecast to work this out.

Steve has a website, which he uses to attract potential new customers with displays of his work. The website also has a customer portal, where Steve can share samples and finished work securely with his customers. He includes the cost of hosting this each month.

He adds up his software subscriptions, for online accounting software, project management software, and to-do lists, and includes these costs.

Steve’s accountant invoices him in March each year. Steve includes this cost in his forecast based on the invoice date.

Steve includes the costs of his landline, mobile phone, and broadband internet in the “telephone and internet” area of the forecast.

He puts in an allowance for office consumables, such as batteries for his mouse and bulbs for his angle-poise lamp.

Steve includes the depreciation of his business’ assets, such as office furniture and computer equipment.

Steve’s accountant advises him how much to include as allowances for business use of home and mileage travelled in his own car.

Once Steve has mapped all his costs, he adds them up, then takes his costs away from his sales to work out his business’s net profit.

Steve can clearly see his business’s seasonal peaks and troughs. He makes little profit, sometimes a loss, in the early part of the year, but makes higher profits in the later part of the year when his sales are higher.

Steve is not happy with the amount of his sales revenue he gets to keep, especially when he considers that he has to pay tax on his profit too. He wonders if he should consider putting his prices up.

It’s now time for Steve to forecast his business’s cash flow and see if he might need to borrow some more money to tide him over.

Step 3 Creating the cash flow forecast

Now that you’ve created your sales and profit and loss forecasts, you can use them as a starting point to map your cash forecast.

How to create the cash flow forecast

Go to Sheet F of the forecast template - we’ve created a column for each month and a row for each type of money coming in or going out.

Money in from your sales forecast

Firstly, you need to record on your cash flow forecast how much money you’re expecting to come in. Use your sales forecast to bring across your sales income, but don’t just copy and paste the figures through - your sales forecast should report income when it’s invoiced, while this cash flow forecast should list income when it’s actually paid. It’s good to be realistic here - some customers may pay early or late, so try to reflect that in your forecast.

Remember, if your business is registered for sales tax such as VAT you should include your sales income inclusive of sales tax, because we're looking at cash coming in (inclusive means to add the sales tax onto the income). This means your sales income on your cash flow forecast will be different from your sales income on your sales forecast, because your sales forecast includes income exclusive of VAT.

Non-sales income

Next, think about any income other than sales that you may have, for example if you're expecting a capital injection from a loan. Add this income on a separate row for each type of income.

Finally, total up all the money in - we’ve done this for you automatically in the “total money in” row of the template.

Money out from your profit and loss forecast

Next, copy across the costs from your profit and loss forecast.

Remember to include your costs in the months you plan to pay for them, not when you plan to incur them. For example, you may pay your staff in arrears, so you should add the money going out in the month that you actually pay them.

If any costs include sales tax such as VAT, and you’re registered for sales tax, remember to record these costs inclusive (or “gross”) of VAT. This is different to the profit and loss forecast, where you included costs exclusive (or “net”) of VAT.

Remember to leave out non-cash costs like mileage and depreciation.

Other costs

Once you’ve worked through your day-to-day running costs from the profit and loss forecast, think about other money your business will spend. This could be on buying new equipment, for example, or paying certain taxes. If you’re a sole trader, it might also include money that you withdraw from the business for your own personal use. Include all these costs on a new row for each type of spend.

Then add up all your money spent each month, and take that away from the money coming in each month, to see how much more you’ve earned than spent each month (net cash inflow) or how much more you’ve spent than earned (net cash outflow). We’ve done this automatically for you in the “Net cash inflow/outflow” row.

Finally, Add this to your bank balance as at the end of the previous month to see how much you expect to have in the bank at the end of the current month. If your bank balance is consistently falling, do you need to borrow more money perhaps, or put up your prices, or try to cut your costs? If your bank balance is consistently rising, could you recruit a new team member, move into a different market, or rent a workspace? Or do you want to invest your cash against a rainy day?

Let’s see how Steve the illustrator puts together his cash flow forecast.

Example of a cash flow forecast

Follow along in Sheet C of the cash flow template

Money In

Steve looks at his sales forecast to plan the first line of his money in. He decides to add extra rows, to make it easier to plan when the money comes in, because different customers take varying times to pay him.

Steve is registered for VAT, and the standard rate of VAT is 20%, so he must remember to include the VAT that his customers will pay him.

Rob pays Steve straight away, so Steve includes those sales in his cash flow forecast in the same months that they appear in his sales forecast.

The payment terms for Steve’s potential comic strip illustration contract are one month in arrears, so Steve will include those sales in his cash flow forecast a month later than he’s put them into his sales forecast.

The greetings card company also pays Steve one month in arrears, so he will include those sales in his cash flow forecast a month after they appear in his sales forecast. He needs to remember to include the money he invoiced in December in January’s cash flow forecast.

Steve includes a row for a loan, in case he needs to look at borrowing money from the bank.

With all of his money in added, he adds a row to subtotal all of these amounts.

Money Out

Steve looks at his profit and loss forecast to plan when money will leave his bank account. He pays most costs in the same month as he incurs them, so he includes them in his cash flow forecast in the same month as they appear in his profit and loss forecast, remembering to put in the costs inclusive of sales tax as appropriate (called “grossing up”). Travel, for example, has sales tax at 0% and so will not be grossed up.

Because Steve is using formulae to bring his costs across from the profit and loss forecast and grossing them up, some of them appear with decimals - this is okay.

Steve pays his accountant one month in arrears, so he puts that cost into his cash flow forecast a month after it appears in his profit and loss forecast, grossing it up because his accountant also charges him VAT.

Depreciation, business use of home, and mileage in Steve’s own car are all non-cash costs, so Steve leaves these out of his cash flow forecast.

Once Steve has brought in all the appropriate day-to-day running costs, he must then think about other cash payments his business might make.

He wants to buy a new computer at the end of the year, so he includes that.

He will pay VAT every quarter, based on the amount he has invoiced his customers, less the amount he has incurred on costs and can reclaim. He needs to remember to include the VAT that he expects to pay in January, which relates to the last three months of the previous year.

Finally Steve, who is a sole trader, puts in the amount he takes out of the business account every month. If his business were a limited company, then he would include his salary under staff salaries.

Steve adds up his outgoings, then subtracts these from his monthly income to work out his net cash inflow or outflow.

Steve’s cash flow and cash position

Steve can see that his business has a net cash outflow in several months, which means that he’s spending more than he earns in those months.

He puts in the business’s bank account balance as at the start of January, and looks to see how much he expects to have in the bank at the end of each month.

Steve is expecting to be overdrawn, so he will need to look at putting an overdraft facility in place and perhaps to arrange a formal loan with the bank. He also decides to think about putting up his prices and to look for more sales, perhaps through an e-commerce site of his own.

If Steve had not drawn up these forecasts, he would not have known that he is at risk of running out of cash, and his bank would have been very unhappy to see his overdraft mounting up. He would have paid interest and unauthorised borrowing fees - extra costs he could ill afford - and, in the worst case scenario, he could have been forced to close his business.

Using your cash flow forecast

Drawing up three simple forecasts for your business needn’t take long, and will give you vital information about your business’s chances of survival in different scenarios.

Taking the time to create these forecasts now and adapting them as the year unfolds will help give your business the best possible chance of success in the year ahead.

Got questions? Ask Emily!