A Beginners Guide to Forecasting Business Cash Flow for Startups
When you first start up a new business, it can feel like you are surrounded by a whirlwind of things to do.
But when you’re so focused on the detailed running of the business, it’s easy to lose track of how well the business is actually performing and if you are in danger of running out of cash.
Ask yourself, do you ever look ahead at:
- How much cash is coming in and when?
- How much cash is going out to pay your suppliers and when?
Far too often, businesses will not plan ahead. Even if their business is thriving, they can end up going bankrupt and then wonder why. More than 45% of startups don’t bother trying to forecast their cash flow in the first year, seeing it as an impossible task that they don’t have enough data to achieve.
But if there’s one thing that I’d like you to take away from this article – it’s this: making a cash flow forecast is absolutely essential.
Understanding and predicting cash flow is the key to keeping track of your purse strings and ensuring you don’t overspend.
A forecast itself is simple – but it can take up some time and effort to put together, which is why so many time-poor business owners put it at the bottom of the priority list – where it stays.
In this article, I’m going to lay out what a cash flow forecast is, why you need one, and how to make one, simply and effectively.
What is cash flow?
Let’s start right at the beginning. Cash flow is just the fancy term for the money moving in and out of your business every month.
That’s all there is to it.
Cash “flow” is an accurate description – I always think of it as money flowing into the business and money flowing out of the business.
While it might seem like cash flow only goes one way sometimes – out of the business usually – it does go both ways.
- Cash is flowing into your business from customers who are buying your products or services, creating an (appropriately named) income stream.
- Cash is flowing out in the form of payments and expenses – like rent, supplies or taxes. Cash flow also looks at when those transactions occur, with the aim of always maintaining a positive cash flow balance.
Positive and negative cash flow
You can think of your cash flow a bit like your personal bank balance. If you have more coming in than going out, you have positive cash flow.
If you have the opposite, with more going out than coming in, you are in negative cash flow. The aim is to stay as much in the positive as possible. It’s not easy to do that, especially with a freshly launched startup.
Investing in a lot of materials to get the business going without any customers already puts you on the back foot. The way around this is to have ‘working capital’. This frees you up to spend without going straight into your overdraft.
For many businesses, this comes in the form of an investment, a loan or a line of credit, which can be paid off later. Once you have established a positive cash flow position, the ideal goal is to stay there.
But there are a lot of things that can change the cash flow of your business, some of which are completely out of your hands.
Customers not paying on time is one of the biggest cash flow issues small businesses face and is one of the big reasons that many startups fail within the first year.
Running out of money
The figure is a lot lower than the 90% claimed by Forbes, but the first year of business is still a dangerous time for startups looking to establish themselves. This is quickly followed by simply running out of money – even if you are technically making a profit.
There are a lot of accounting tricks you can utilise to make your startup look profitable on paper while you reinvest in the business, but it takes real cash to pay the bills.
You can also encounter unexpected expenses, which as a new startup you are often less equipped to handle.
While more established businesses might have a buffer of savings to fall back on in the event of the unexpected, startups will often struggle to bring their cash flow back into the positive.
But it’s not all doom and gloom – the key to keeping your spending in check and money in the bank is simply to forecast your cash flow.
Strange as it sounds, you can plan for the unexpected.
Alright, so what is cash flow forecasting?
A cash flow forecast is a plan that shows how much money you expect to receive, and how much you expect to pay out, over a set length of time.
Some business owners like to plan over the course of 12 months, while others prefer to focus in on 3 or 6-month periods at a time.
These forecasts should be re-visited regularly and compared to your actual cash flow so that you can see how closely the numbers match up.
Once you have a year under your belt, you will be able to start comparing your numbers and generating a cash flow based on previous year’s performance. But for the first year, your numbers might be a bit more flexible.
After all, how can you know for sure if your business is going to explode in the first month, or if it’s going to be a slow burn for the first 18 months before it takes off?
A basic cash flow forecast will help you identify what your business is going to need support – either from your own pocket or some other form of finance.
Forecasting is seen by some as nothing but educated guesswork, but with some effort, you’ll be able to find the evidence you need to support the numbers you calculate.
It’s hard work, but it’s worth it!
Why is a cash flow forecast so important for a startup?
The old saying that ‘cash is king’ is never more accurate than when dealing with a startup.
Cash (and cash flow) is the lifeblood of a small business, and forecasting it helps a startup predict what’s going to happen and ensure it will have enough cash to survive.
It can help you foresee any potential problems that might arise in the year ahead, and help you make decisions about the future direction of the business. It can also be the thing that stops you going bankrupt, despite being highly profitable.
As we mentioned before, cash flow is all about keeping a positive balance by monitoring when transactions happen. If you’re not paying attention to when money is due to come in and go out, you could be in serious trouble.
For example, you could be pulling in thousands in orders, but not receive a penny of that money for 60 days.
During that 60-day period, you must buy the supplies to fill the orders, and you need to pay the rent. If you don’t have enough cash already in the bank to cover this, your cash flow will go negative.
Negative cash flow, even temporarily, can create some real problems for small businesses and startups. Once you are operating in a deficit, it’s hard to get out of debt.
Unless you can get hold of cash quickly you won’t have the ability to pay your suppliers for the materials or services you need to sell more and create inbound cash to balance your business.
You will also be unable to pay off any loans or other debts you owe, resulting in a lot of stress from chasing debtors and a black mark against your company for late payment.
These problems all have their own causes, which can range from disorganised accounts to out of sync payment terms and accumulation of bad debts. Businesses who keep an eye on their cash flow for the future are less likely to experience these issues.
For those who don’t, cash flow problems could end up killing their business stone dead (like 25% of startups who fail every year due to cash flow problems). This is why cash is so important.
Having a clear picture of your cash flow is critical to operating your business long term and understanding it’s financial health. You need to plan so you can see any shortfalls coming a mile off and find a way to plug the gap before it’s too late. You may have a perfectly viable, growing business but if you don’t have one eye on the future it could all go wrong.
What about profit and loss reporting?
One of the other things you will hear talked about a lot alongside cash flow forecasting are profit and loss statements. While the two are very closely linked, they are different things, and you should be producing both in order to understand the financial position of your business.
Cash flow is about looking forward to the actual flow of real cash in and out of the business. Your profit and loss will look at the difference between the price your business charges, the sales volume you can achieve and the amount it spends to determine whether you can make a profit.
It’s a truer picture of how your business is performing. The bottom line of your cash flow can look healthy but that might just be due to all the loans you are taking out! On the Profit & Loss, there is nowhere to hide, loans are accounting for in their true form which is a loss to the business (there is no such thing as free money!).
As we said earlier though, you can look profitable and still run out of cash! That’s why you need both for the complete picture.
The Profit & Loss doesn’t care about when cash impacts occur
Note that we said the “amount your business charges” – instead of the amount that your customers actually pay you!
Unfortunately, not all your clients will pay their invoices, or at least not pay them on time. Profit describes what is owed to the business each month, rather than what is actually paid that month in cold, hard cash.
It’s not just income which is treated this way. On the ‘loss’ side of profit and loss, expenses can be recorded immediately, rather than when the cash actually leaves your bank account or wallet. It’s what you owe, not what you have paid.
Here are a few other areas that a Profit & Loss statement will deviate from simple cash in/cash out
- Asset purchases: The cost of equipment is spread over its useful life, rather than in a single chunk like you would in a cash flow forecast. That makes sense – it’s adding value for that long, so you should represent the cost alongside the value. This cost of equipment spread over years is called depreciation.
- Accounts payable: Overheads and one-off costs impact your profit as soon as you incur them. Even if your rent is due to be paid a month in arrears, it is still recorded as a ‘loss’ straight away.
- Loans: Loans don’t generate profit, they generate a loss. They are used to help your cash flow, and so while in your cash flow they will look like a positive, the reality is that on a profit and loss they will appear as a negative. By taking out a loan you immediately have more cash – but on the P&L you haven’t actually gained anything – there is no profit from taking out a loan because it must be repaid – and the interest paid on the loan is a loss to the business. As the balance goes down, the interest charge often decreases, so the impact on the P&L starts high and goes down with it. Normally your repayments stay the same – but your profit & loss statement isn’t interested in those repayments – they only affect your cash flow.
- Accounts receivable: When you make a sale, it shows up on your profit & loss report straight away – no matter when the payment is due. This is called your sales revenue. In contrast, revenue shows up on your cash flow when it’s due to arrive in your account (which may be later depending on the payment terms).
Are you confused yet? Don’t worry, it’s not as complicated as it sounds. All you need to do to generate and manage both a cash flow forecast and a profit & loss is break them down into smaller, simpler tasks, and pull them together at the end.
That’s what we’re here to help you with.
How do I start forecasting my cash flow?
So now you know why you need to forecast your cash flow, but how on earth do you do it? After all, you’re a brand-new business, so how can you possibly estimate your incomings and outgoings? Do you just pick some numbers out of the air and start there?
Of course not! And you don’t need a professional accountant to help you either.
First, let’s look at the basics of a cash flow forecast. The ingredients are quite simple really:
- Decide how far you will plan into the future (1 year, 2 years, more?)
- Estimate your sales (you can be rough here)
- Estimate your costs (you should have a pretty good idea of these)
- Plot out when you will be paying and receiving money
The length of your forecast may depend on the kind of business you are in. If you’re a software developer building apps on a 2-year development cycle, you may need a forecast to cover that 2-year cycle. Likewise, many startups do not become profitable until their second year (or even later), so ensuring you have a cash flow forecast to cover this vital period is essential.
Once you have decided on the length of the forecast the first thing to do is make a list of the business’ financial activities – by this, I mean anything the business does that touches money in any way. It should be as comprehensive as possible. Even the smallest cost or income should be noted down, as this will help you create a truly accurate forecast (which will be much more useful to you moving forwards too). Then it’s a simple matter of working through your income, and then your costs, before putting it all together. Don’t worry – we won’t abandon you! Our guide is here to help at every stage, along with our free cash flow forecast software.
So we’ll break this down into:
- Cost of sales & operating costs
- Asset purchases
- Loans & funding
1. Create your sales forecast
The first step in creating your own cash flow forecast is creating a sales forecast. This is essentially a plan of everything you expect to come into the business over your chosen period. This is usually broken down by month so that you can keep a closer eye on what’s going on and adjust your spending if sales aren’t going as well as predicted. Now, you could just have one line that says, ‘revenue in’ and fill in each month with a single number. That would be fine as a start – but breaking this down into individual sources of income will provide you with more a more grounded, well-researched and adaptable forecast. But beware – you can go too far in the opposite direction here.
For example, if you’re starting up a café, you might be tempted to write separate lines for coke, diet coke, pepsi, diet pepsi and so on. This would take up a huge chunk of time and quickly become unmanageable. So instead, you could group them all into ‘cold drinks’ for the purposes of cash flow forecasting. So, you might choose to break your café’s sales down into:
- Hot drinks
- Cold drinks
- Sandwiches and soups
- Cakes, muffins and other sweets
- Catering events
This is a good balance between detail and practicality, and still provides granular insight into what you are selling.
Now, existing businesses would find this easy, because they would simply look at their sales form the same period last year. But if you’re a new startup you might not have a clue how much you will sell of each of these things – and that’s ok! You can do a lot of research into what similar businesses sold in their first year, what businesses in your local area sold in their first year and how much you think you could sell over your chosen period.
The most important piece of advice we could give you when forecasting your income is to be realistic. After all, this plan will likely influence how much you spend or invest, and you don’t want to be overspending based on an incorrect forecast. So, remember that these figures should be what you think you can actually sell, not your target of what you would like to sell. A simple way to get started with estimating sales is to use the following technique:
- Calculate potential reach per day/week/month (the size of market you can target)
- Calculate the proportion that will view your products
- Calculate the proportion of viewers that will make a purchase
- Multiply this by an average purchase price.
An example would be a shop set up in a shopping centre:
- The shopping centre has a daily footfall of 2000 people (reach).
- 5% enter the shop leading to 100 viewers.
- 20% of the viewers purchase a product averaging £80.
- This leads to a daily income of £1600 and a monthly revenue of £48,000
But, some days are different to others. Weekends see higher footfall in our shopping centre, while midweek is a dead time. Make you income assumption as realistic as possible by considering these possibilities.
Example sales forecast
If you’ve never put together a sales forecast before, it can be difficult to understand how this would look in the real world. So, to help, we have put together an example scenario for you of a relatively new startup sole trader working in a simple business, and what his sales forecast might look like:
“Kevin is an illustrator of children’s books. He works closely with an author, Erika, whose books he illustrates. Erika plans to write a new book early next year so Kevin 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.
Kevin plans his sales for next year. 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 VAT, so he records his sales net of this. He records his sales in round numbers, because this is a forecast rather than an exact prediction.
What Kevin’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 Erika will pay him a total fee for the project rather than a fee per illustration).”
Factor in the extras
Once you have your base figures from this exercise, you can start factoring in anything that might affect your sales (both positively and negatively). For example, you will need to account for any seasonal spikes that could lead to an increase or decrease in traffic. So, if you sell gifts, you are likely to see spikes around Christmas, Mother’s Day, Father’s Day, Valentines and other gift-giving holidays. If you sell ice cream, you are likely to see a lull as the weather gets colder. All of this will have an impact on your business cash flow, so it’s important to factor it in.
And there’s one more thing to factor in. As a new startup, you will undoubtedly have a period of time at the beginning where nothing much happens. This is while you are networking and promoting your business, letting the world know you exist. This is known as your ‘sales ramp-up period’, and covers the time it will take for you to go from 0 sales to a fully operational business. The length of this period will differ hugely depending on the type of business you are and your location. For example, a new high street shop may have a fairly short sales ramp-up period due to their public location, whereas a new accounting firm might have a longer ramp-up period as they make people aware they are there.
Once you have broken down all sources of income in this way, it’s time to look at the other side of the coin – your costs.
2. Forecast your costs
This is the part that makes most startups cringe. Starting a business is rarely a cheap thing, and it’s very easy to go overboard on the spending in the beginning. A cash flow forecast helps you to understand exactly what it is you need to spend, and when, so that you can plan your investments to match your income and avoid dipping into the red. The process for this is basically the same as with your sales forecast, but instead of filling in what you expect to sell, fill in what you expect to spend. No payment is too small to be missed off this list, and you should try and make sure you are fairly accurate with when the payments would be made, as this will be important later. Some examples of payments you may need to include are:
- Premises rent
- Employee salaries (including yours)
- Insurance payments
- Purchasing stock
These costs can then all be sorted into their respective groups. There may be 8 or 9 expenses that are all directly related to your sales (cost of sales), while 4 are one-off equipment purchases and 3 are your annual insurance payments. If you’re not sure what belongs in what category, we have a few helpful tips for you.
Cost of sales
Cost of sale expenditure is directly attributable to the production, delivery and sale of the goods or services sold by your business. This is usually most relevant to businesses selling products. Your cost of sale should include the physical cost of the materials used in creating the product, along with the direct labour costs involved in making it. Do not indirect costs here – like marketing or distribution – you’re just looking at exactly how much it costs to make one product.
You should split out costs of sale from operational costs in your cash flow forecast because they are so closely related to the sales you make. The key here is timing. You might decide to buy or make a product a month before you get income from selling it, which will affect your cash flow. You might bulk buy products to last you several months, or you might choose to only order stock when a buyer comes in. All of these little variations in the costs of selling can have a huge impact on your cash flow, so it’s important to plan them correctly. Using this number, you will be able to work out not only how much each sale is costing you, but how much profit you are making on each one as well.
Next, we take a look at operational costs. There are often easier for startups to put together because these are fixed outgoings. You’ll be paying these costs whether you make £1 a month or £10,000 a month because they are the costs that keep your business going. So, you will have fixed costs for things like:
- Phone line rental
- Internet connections
- Utility bills
And all sorts of other day-to-day running costs for your business. These are (or should be) known quantities, with no guesswork involved at all, so this section should be nice and quick! Make sure you reference your list against your direct debits to be sure you haven’t missed anything – like insurance or bank charges. It’s also worth including things like salaries in here as well, as these are fixed overheads too.
Put together, these two sections should give you a fairly good idea of how much money you’ll need to make just to cover your costs. It’ll also make you more aware of when the big costs are likely to hit your business. For example – do you pay all your bills monthly, or do you get hit with a big annual bill? Is there one month where the costs all seem to pile up, and you need to make sure you have enough in the bank to cover everything? Pulling apart when your ongoing costs occur can help you see the bigger picture of your businesses financials before you even start trading.
3. Asset purchases
Most businesses need to buy certain items in order to run their business. Whether that’s a computer or a piece of machinery, anything that retains value for a year after its initial purchase is classed as an asset to your business. These are items you will physically own, usually for a long period of time. It’s worth costing them out separately from your operational costs simply because they will have a big impact on your cash flow.
Now, if this were a balance sheet guide then I’d expand on this in a bit more detail. But to give you an idea, here is an example that most people will recognise; the purchase of a car. You have an initial cost (this hits your cash flow quite hard) but then it also has value after the purchase. So, unlike a cost such as rent, the value goes on your balance sheet, which, in the case of a car, immediately starts reducing over time due to depreciation. Depreciation does not appear on your cash flow because it’s not actually money leaving your bank account, it’s just the value of the asset decreasing. Finally, a few years down the line you might decide to sell it (or write it off). The sale is at the depreciated value, and the income from this sale appears on your cash flow.
The types of assets you are likely to purchase depend on the type of business you are running and can vary hugely. For example, an office based business will need to buy office furniture and computers, whereas a retail store will need shelving units, storage areas and tills. A tradesman will need a van and high-quality tools, while a coffee shop will need coffee machines, grinders and other specialist equipment. All of these things will need to be bought at a certain time and need to be planned for in advance so that your cash flow stays positive.
4. Loans and repayments
Funding is an interesting one because different accountants will tell you to put it in different places. Personally, I like to consider it as a separate line item, so that I can be clear about where money is coming from or going to, and when. This is particularly important when you take out business loans. The initial loan will inject some cash into your business, which needs to be accounted for in the cash flow. You then need to be aware of any repayments and interest on the loan, as this will also impact your cash flow.
There are lots of different ways loans can be structured, so we can’t tell you exactly how that will impact your cash flow. But whatever loan arrangement you have, there’s no such thing as free money, so ensure you can handle the costs associated with repaying the loan and well as getting the most benefit possible from the loan you take out.
5. Don’t forget VAT!
Of course, there is another outgoing that many businesses need to (but forget) to budget for, and that’s VAT. If you are VAT registered, you need to bear in mind when your bill will arrive and plan for it, as it can dramatically affect your profitability. But if you look at a profit and loss statement for a business, you won’t see VAT anywhere. That’s because VAT doesn’t actually affect your profits. VAT isn’t actually your money (you just act as a kind of tax collector for the government)! But it does pass through your business – so it does affect your cash flow. If you’re VAT registered, you will be collecting an extra 20% in payments from your customers, which will go into your bank account with everything else. But at some point, in the year, you will get a VAT bill, and that money will need to go back out.
Something that trips up a lot of startups is forgetting to set aside the VAT or even account for it, so when the VAT bill is due they end up scrambling for cash to pay it. A good tip we like to suggest is setting up a separate savings account and putting money aside for your VAT bill every month, so that you’re not caught short. This also makes it easier to forecast your cash flow for the year. You simply have to allocate a set amount each month to go into the VAT account. Simple!
Putting it all together
Now here’s the good news – you’ve done most of the hard work already. Everything you’ve just written down can be simply divided up into ‘inflows’ and ‘outflows’. So, at a basic level, you will have:
- Product/ service sales
- Asset sales
- Loan drawdown or other investment capital
- VAT received
- Operational costs and salaries
- Cost of sales
- Asset purchases
- Loan repayments
- VAT paid
Once you have added all of this together should be a forecast of the balance in your bank account at the end of each month. So now, you have all the information you need to create a cash flow forecast – you’ve just got to put it all together! Many businesses will opt to use spreadsheets to manage their cash flow forecasts, so we will give you a basic guide to setting one up here. First off, you will need to open Excel (didn’t I say it was basic?):
- In a new spreadsheet, set up the months as column headers along the top.
- Add a total column at the end of each year.
- Set up rows for your inflows and outflows, with separation between the two so they don’t get muddled.
- Break them down into individual rows as described earlier in this article.
- Add a total at the bottom of Inflows and a total at the bottom of outflows.
- Add a total at the bottom of the entire report which calculates the net of Inflows – outflows.
- Create a cash flow chart using the totals to visualise your forecast.
This last one is optional, but having a chart gives a different perspective on the data which can be surprisingly useful for understanding what’s going on.
Of course, if you’re not great with numbers, don’t like spreadsheets or just think all of this sounds like too much work (we wouldn’t blame you) then there is an alternative. We designed Brixx to do the heavy lifting – creating professional financial reports based on simple inputs. Brixx is free to use for making simple plans, which should be suitable for checking the feasibility of your business idea.
Brixx allows you to build a model of your business from the different financial components that make up the business. Using this data, you can build a custom cash flow forecast that will reflect what you can expect your business to look like for the next 12 months. Reports and charts are automatically calculated, so you can track how well your new business is adhering to your predictions. Brixx models are designed to be tested, and changed, so unlike a spreadsheet you won’t need to check every cell and formula if you want to try out something new.
Forecasting for seasonal businesses
Before we wrap up, there is one kind of business for whom forecasting cash flow is an absolute essential – and that’s seasonal businesses. Any business that will thrive at one particular time of year (Christmas, Easter, summer holiday events, Valentine’s Day gifts and so on) will always find that they are very busy for 10% of the year, and have a large lull for the other 90%. That can make staying positive for that 90% very difficult. But there are some techniques that many seasonal businesses will employ to manage their cash flow through these tougher times:
- Find alternative business options or activities for the slower part of the year.
- Hire employees only during the busy times and lay them off when the season ends.
- Develop banking relationships that allow for the extra flexibility required.
- Close their doors and reopen the next year for the busy season.
- Save part of the earnings during the busy time to cover expenses during the slower part of the year.
- Arrange for vendor relationships that allow them to make larger payments when cash flow is high and lower payments during slower times of the year.
- Find ways to create off-season demand through partnerships with other businesses, by offering deals to local customers, or by moving sales online.
On top of these options, seasonal businesses also need to spend a lot of time nurturing their cash flow. These businesses often develop monthly sales spending and cash flow forecasts. Cash flow will become the managing driver behind spending, and changes will be carefully monitored. If you’re going down the route of shutting down for a large section of the year, your job actually becomes a little easier – since you don’t need to estimate fluctuating year-round costs.