Why is a cash flow forecast important to a small business?
Every business needs to have a good handle on its cash flow. After all, cash is the lifeblood of any business, and keeping it flowing smoothly is essential for keeping the business running. A cash flow forecast is a tool that can help businesses do just that.
A cash flow forecast is simply a prediction of the future cash inflows and outflows for a business. It can be used to anticipate and plan for potential cash flow problems that might arise in the future. In this article, we’ll take a look at why a cash flow forecast is important to a business and how it can be used to help manage cash flow.
What is a cash flow forecast?
First of all, let’s define what we mean by a cash flow forecast. A cash flow forecast is a projection of a company’s future inflows and outflows of cash. In other words, it’s a prediction of how much money will be coming in and going out of the business over a specific time. The period can be anything from the next week to the next year.
Every business, especially SMEs should have a cash flow forecast because it can help them to:
- Anticipate and plan for potential cash flow problems
- Make more informed decisions about how to allocate their resources and finances
- Understand the impact of changes in their business on their cash flow
- Help them to access finance by providing lenders with a clear picture of their future cash flow
Why is a cash flow forecast important?
So now that we know what a cash flow forecast is, let’s take a look at why it’s so important for businesses.
1. Helps in decision making
Decision-making is a huge part of any business and cash flow always plays a big part in that. After all, every decision a business makes will have an impact on its cash flow. A cash flow forecast can help businesses to anticipate how these decisions will affect the future and plan accordingly.
Most importantly, a cash flow forecast can help businesses to avoid making decisions that could jeopardize their future cash flow. A single bad decision could cost a lot and even lead to the downfall of a business.
2. Helps you track unexpected expenses
Another reason why a cash flow forecast is important is that it can help businesses to track unexpected expenses. We all know that unexpected expenses can pop up from time to time, and they can throw a wrench in your cash flow. A cash flow forecast can help businesses prepare for these unexpected expenses and plan accordingly.
You can plan for emergency funds so that you don’t have to worry about cash flow problems when they happen. This way, you can focus on getting the business back on track without worrying about the financial consequences.
3. Gives a better understanding of the financial health of a business
A cash flow forecast can also give businesses a better understanding of the overall financial health of the business. This is because it provides a clear picture of all the money coming in and going out of the business. This information can be very useful for making informed decisions about the financial health of the business.
In addition, you will be able to take a closer look at your debts, assets, and equity. The important thing is to have a good understanding of your financial situation so that you can make decisions accordingly.
4. You can eliminate unnecessary costs
Most SMBs don’t know where their cash is going. They believe that all their costs are necessary and there’s nothing that can be done to reduce them. However, this is often not the case. A cash flow forecast can help businesses to identify unnecessary costs and eliminate them.
For example, you may be able to find that you’re spending too much on advertising or that you’re paying for unnecessary office supplies. Once you identify these unnecessary costs, you can take steps to reduce them and improve your cash flow.
5. Allows businesses to focus on making a profit
Every business wants to make a profit, but not all businesses have a clear understanding of how to do that. A cash flow forecast can help businesses to focus on making a profit by giving them a clear picture of their inflows and outflows.
When you know where your money is coming from and where it’s going, you can make informed decisions about how to allocate your resources. This information can be invaluable for making decisions about pricing, marketing, and product development.
6. Helps businesses to set goals
Setting goals is an important part of any business, but it’s often difficult to know where to start. Not having clear goals can lead to a lot of wasted time and money. With the help of a cash flow forecast, you can set realistic goals for your business and track your progress over time.
Setting goals is the process of a step-by-step action plan that will help your business achieve its objectives. This could be anything from increasing sales by a certain amount or reducing costs by a certain amount. A cash flow forecast can give you the information you need to set clear and achievable goals for your business.
7. Helps businesses to track progress
As well as helping businesses to set goals, a cash flow forecast can also help businesses to track their progress. This is because it provides a clear picture of all the money coming in and going out of the business.
This information can be very useful for monitoring the progress of your business and making sure that you’re on track to achieve your goals. It can also help you to identify any problems that might be affecting your cash flow so you can be prepared to deal with them.
8. Improves communication between businesses and their stakeholders
Good communication is essential for any business, but it’s especially important for businesses with complex financial affairs. A cash flow forecast can help businesses to improve communication by providing a clear and concise picture of their financial situation.
This information can be very useful for discussing the financial health of the business with stakeholders such as shareholders, creditors, and employees. It can also help to improve communication between businesses and their banks.
1. Why is cash flow more important than profit for a small business?
Cash flow is more important than profit for a small business because it ensures the availability of funds to cover day-to-day expenses, pay employees, invest in growth opportunities, and handle unexpected costs. Without sufficient cash flow, even profitable businesses can struggle to meet their financial obligations.
2. What is a cash flow forecast for the business for the short term?
A cash flow forecast for the short term is a projection of a company’s expected cash inflows and outflows over a specific period, usually ranging from the next week to the next few months. It helps businesses anticipate their cash needs and ensure they have enough liquidity to cover expenses during that period.
3. Is cash flow more important than profit in the short term?
Yes, cash flow is typically more important than profit in the short term. While profit represents the amount of money left after deducting expenses from revenue, cash flow focuses on the actual movement of cash in and out of the business. In the short term, businesses need sufficient cash flow to meet immediate financial obligations, regardless of their profitability.
4. What goes into a cash flow forecast?
A cash flow forecast includes several components, such as projected cash inflows (e.g., sales revenue, loans, investments) and projected cash outflows (e.g., rent, utilities, inventory, salaries, and loan repayments). It also considers other factors like accounts receivable, accounts payable, and any anticipated changes in cash reserves or investments.
5. Is the cash flow forecast the same as profit and loss?
No, a cash flow forecast is not the same as a profit and loss (P&L) statement. While both provide financial insights, they focus on different aspects. A cash flow forecast predicts cash inflows and outflows, helping to assess liquidity and ensure adequate cash reserves. In contrast, a P&L statement summarizes revenue, expenses, and profit or loss over a specific period, indicating the company’s financial performance.
In conclusion, a cash flow forecast is crucial for businesses, particularly SMEs, to effectively manage their cash flow. It enables companies to anticipate and plan for potential cash flow problems, make informed decisions about resource allocation, understand the impact of business changes on cash flow, and provide lenders with a clear view of future cash flow for accessing finance.
Additionally, a cash flow forecast helps in decision-making, tracking unexpected expenses, gaining a better understanding of financial health, eliminating unnecessary costs, focusing on profitability, setting and tracking goals, and improving communication with stakeholders. By utilizing a cash flow forecast, businesses can enhance their financial management, mitigate risks, and ensure the smooth operation and growth of their enterprises.