The uncertainty of levels of cash in any business is one of the most crippling and stress related issues Directors and Managers face. With so many variables coming into play, forecasting your cash balance seems an impossible task and therefore more often than not put to one side. Instead you rely on gut feeling and your current bank balance to steer future decisions.
But let’s take a step back for a minute and think about those “many variables”. Net cash balances are driven by two things. Money coming in and money going out. So let’s consider these two individually.
Money going out
Expenditure in most organisations is driven by decisions to purchase goods and services or pay for staff related costs. Some of these expenditures are known in advance and the timings of when the costs will be paid. Examples will include regular supplier payments, payroll costs, direct debits etc.
The next set of spends are those you make to your regular supply base. For these you will probably have terms and therefore will be able to forecast in advance what you are due to pay based on what you are currently ordering. For the future months you can look at spends by supplier, what you spent last year or try to understand level of spend against your sales. Finally you will have one-off payments and irregular spends. These are difficult to forecast due to their nature, but it is still possible to factor a level of spend into your forecast.
So if we wanted to forecast out our cash flow for the next 2-3 months we should, to a certain extent, be able to forecast payroll costs, regular payments and direct debits. We could probably estimate for the main suppliers some rough numbers of spends with them and when those payments would leave the bank. Remembering the 80:20 rule you don’t need to forecast every single supplier, just the ones that make up a significant part of your cash outflows.
Money coming in
This tends to be trickier as money coming in is not driven by a decision made by you, but by your customer. What you do have available to you is some trend information on sales. What your sales are running at currently, what they were last year. From this you can probably start to put together a sales forecast for the next 2-3 months. Sales are one thing but payment is another so now we need to consider your debtor payments, when are your customers going to pay you. Well in a similar approach to your suppliers the nature of your business may be that you have customers on terms. For those customers you will know roughly when they pay and what they have bought from you recently. For the rest again using the 80:20 rule for your debtor days and using your sales forecast you should again be able to put together some rough numbers around when your debtors will pay.
Now we have some forecasted numbers for money coming in and money going out. The forecast is built up from different financial information, some with more certainty than others. The key is to maintain a regular forecast so that you can learn and sharpen your forecast as you understand more and more about your business. It doesn’t need to be sophisticated or overly detailed, and forecasting many of your knowns will give your forecast some credibility. The key is to keep it simple, keep it up to date and review how successful it is periodically. Good forecasts evolve.