How to prepare a cashflow forecast
Matt Byrne
Director
Summary
Cash is the lifeblood of any business. Without cash, you can’t pay for products, pay your staff, keep the lights on or pay yourself. Every business is dependent on having more cash coming in than cash going out.
Most businesses manage cashflow by looking at their bank account and a rough estimate in their head of what cash is coming in over the next month and what’s going out. Why most can survive this way, it’s not a pleasant feeling chasing your tail month to month not knowing if there will be enough in the bank.
%
A recent Xero report stated that 92% of businesses have at least one month of negative cashflow each year.
To help you better track and manage your cashflow we suggest you create a cashflow forecast and track this consistently. Whether you do this in excel or using an app such as FloatApp, the process is broadly the same albeit with different levels of automation.
A cashflow forecast estimates the cash coming in and going out. Creating a forecast is a bit of an artform and is generally easier to do over a shorter term. We’d suggest you maintain a very detailed forecast for the next month and a slightly less detailed forecast over the next 3 months. This will highlight any immediate cashflow issues while also helping you keep an eye on the horizon for any significant shortfalls.
Before we get into the weeds, we first want to highlight that a cashflow forecast is different to calculating your profit or loss. While a profit and loss shows only the income and expenses on an accruals basis (i.e. when the invoices are raised), a cashflow forecast shows all cash coming in and going out of a business. A cashflow forecast includes things such as owner drawings, finance and loan repayments and GST payments that aren’t included on the profit and loss.
To create a cashflow forecast, start with the simple stuff:
Fixed and recurring costs
- Have a look through your historical cashflow (either directly from your bank account or via a cashflow report from your accounting software) to identify those costs which are consistent. Recurring payments such as subscriptions are easy to budget for as they are the same amount every month and are paid on the same day. The same generally applies to phone and internet expenses, rent and outgoings, loan repayments and bank fees etc.
- If you pay employees a salary, you can also then budget for the weekly, fortnightly or monthly net wages (we’ll discuss super and PAYG in more detail below). If you have fluctuating wages (i.e. for casual employees or overtime) this may be a bit more difficult to budget for but you could use an average adjusted for seasonality and/or other relevant factors.
- Next look for annual payments such as insurance premiums or car registration renewals that might be coming up in the forecast period. If you have a finance lease expiring, also consider whether there is a balloon payment coming up.
Once you’ve ticked off the easy wins, next it’s time to look at the trickier items:
Revenue
Most service-based businesses we work with have a reasonable handle on what’s in the sales pipeline for the next month. However, doing the work and getting paid for it are two very different things.
To estimate cash coming in have a look at the due date of any invoices you’ve already issued and then make adjustments based on how timely your customers are at paying their invoices. Software such as Xero will allow you to run an income by customer report which shows the invoice date and actual payment date for historical invoices. From this you can determine the number of days it takes your customers to pay on average (referred to as ‘debtor days’) and then apply that to the current invoices.
Use the same methodology for the invoices you expect to issue over the coming months and you should have a pretty good idea of when cash will realistically land in your account. Making sure people pay you on time is a different kettle of fish which we’ll deal with in a future blog article.
For product based businesses, cash is usually received at the time of sale so timing is less of an issue but the actual estimated sales is the difficult part. To estimate sales volumes we’d suggest reviewing historical sales data against the drivers to estimate sales volumes. Drivers could include advertising spend or seasonality. You should be able to spot a trend such as for every $1 spent on advertising, you get $10 of sales or June is generally 30% lower than May. These are just examples but there is usually some driver in the background that will allow you to estimate sales volume in a scientific way.
Cost of sales
If you’ve been selling that particular product(s) for a while you should be able to calculate your gross profit margin and use this to calculate your estimated cost of sales.
The formula to calculate your gross profit margin is:
Once you know your gross profit margin you can then calculate your forecasted cost of sales using the gross profit margin and your estimated revenue.
Calculating your estimated cost of sales is the easy part, it’s the timing of the purchasing that is more difficult to estimate. Once you get pretty good at estimating your income you’ll know how many units of each product you need and when you’ll need to buy factoring in the current supply chain issues.
If you’re struggling to understand when and how much stock to buy, we’d suggest implementing a robust stock management system that has inbuilt tools to give you the insights you need. Fair warning though, these pieces of software aren’t cheap but if you’re serious about your business, they are worth the investment.
Business activity statements – GST & PAYG withholding
BAS payments is something that often catches businesses out, particularly growing businesses. There are some relatively simple ways to estimate your outgoings for the BAS.
The first thing to do is the understand when the payments are due. The due date will depend on whether you lodge yourself or through and agent and whether you lodge on a quarterly or monthly basis.
Quarterly lodgement due date |
Month lodgement due date |
|
Lodging yourself |
28th day after the end of the quarter |
21st day after the end of the month |
Lodge through a bookkeeper/accountant |
25th day in the 2nd month after the end of the quarter |
21st day after the end of the month |
For those that have higher wages, you may lodge GST quarterly and PAYG withholding monthly. You can find out the frequency by checking with your accountant or bookkeeper or by logging into the ATO business portal.
An overly simplistic way to calculate the estimated GST payment is 10% of sales less 10% of expenses that you pay GST on (i.e. don’t include wages or super in this). There are of course some adjustments to this but it gets complicated so start with that and chat with your accountant or bookkeeper to refine that calculation.
The amount payable for PAYG withholding is known at the time of completing pay runs. Based on historical payroll data you should be able to get an idea of the average PAYG withholding as a percentage of wages and you can apply that to the estimated wages in your forecasted period.
If you pay PAYG instalments the amount will be either a fixed amount each quarter or a percentage of your revenue. Check your previous lodgements to see how your instalments are calculated or chat with your accountant.
Superannuation
Super is a big cost for wage heavy businesses but thankfully it’s pretty easy to calculate. Once you know the wages, it’s just a matter of multiplying this by 10.5% to work out the super. Super is payable by the 28th day following the end of each quarter so be sure to factor this in.
Income tax
The last major cost to consider is income tax. If you complete annual tax planning (which we think is a must for all businesses), you should know well in advance what your annual tax liability will be and you can factor this into your cashflow forecast including a provision for savings so enough cash has been set aside when the tax bill lands.
If you don’t complete tax planning, taking a high level estimate such as 30% of profit is likely to cover most of the tax bill.
In Summary
Every business is different and some businesses will have income and expenses unique to them which we can’t cover off in this general article. The benefit of completing a regular forecast is that you’ll get to know the cashflow of your business in detail and get better control.
As we said above, cashflow forecasting is a bit of an artform but the more you do it the better you get. One very important thing that will help you get more accurate is to compare your actual performance against the forecast. Each month you’ll be able to see where your differences were and whether they were bad forecasting or things out of your control. This will help you month-on-month and after 6-months, you should be a pro.
Final Thoughts
Cash is the lifeblood of any business so you should be keeping an eye on it like a hawk. Getting in the habit of running regular cashflow forecasts will help you get control of your cash.
If you need help with that exercise or just want a sounding board, reach out to the team at Day One Advisory.