Projecting cash flow: how and why

Every SME owner knows that good cash flow is crucial to keeping a business afloat. But that didn't prevent inadequate cash flow from being the top cause of business failures in 2016-17, according to the Australian Securities and Investments Commission.

The organisation revealed that 47 per cent of insolvencies during the financial year were due to poor cash flow or high cash use. Cash flow has topped the rankings three years in a row and the proportion of businesses citing this as the reason for their operation collapsing is on the rise.

An effective cash flow forecast can help SMEs predict the amount of money they will have on hand for the future and prevent the business from going under.

How to project cash flow for an SME

Creating a cash flow statement enables you to track payments and expenses flowing in and out of your business. Some SME owners get distracted by sales and revenue figures, but this is just a small part of the cash flow formula.

Most businesses set their cash flow statements to cover a one-year period, divided up into months.

There are several steps to building an accurate cash flow plan:

1. Calculate your total monthly cash inflows;
2. Calculate your total monthly cash outflows;
3. Use inflow and outflow figures to determine net income;
4. Add or subtract net income from your opening balance;
5. Review past and future cash flow forecasts; and
6. Invest surplus cash flow or seek finance options.

Let's look at each of these areas in more detail.

1. Working out your monthly inflows

The most obvious cash inflow for your business is sales. Your past year's payments are a helpful starting point, but you'll need to adjust the figures where necessary to account for any expected growth or decline in sales.

If you are a new business, you can forecast sales using customer surveys and additional research to map expectations.

Other potential cash inflows include:

• External investment in the business;
• GST rebates and similar tax payment refunds;
• Government grants;
• Asset sales; and
• Payments received through loans.

2. Determine business expenses and other outgoings

Compiling an exhaustive list of business costs is a daunting job, but it's the only way to create an accurate forecast. You should track every payment your SME plans to make – down to the very last paperclip if possible.

Here are some of the expenses you'll need to keep in mind:

• Rent and asset purchases;
• Utility bills;
• Staff wages;
• Loan payments;
• Office supplies;
• Insurance;
• Taxes and one-off fees; and
• Dividends and other payments to owners.

If you're struggling to keep track of all your business incomings and outgoings, contact an experienced accountant to help you calculate the numbers.

3. Calculate your net income

The net income of your business is the total monthly inflows minus the outflows. This should be a fairly simple exercise and will give you a good idea of what your cash flow situation will be across the forecast period.

Obviously, you'll be hoping for a positive figure each month, notwithstanding seasonal trends and one-off expenses that may cause a few wobbles along the way.

4. Measure net income against opening balances 

Your net income must be added to or subtracted from your opening balance, which represents the amount of cash on hand your business has at the end of each forecast period.

For example, if your business had a surplus of $100,000 at the end of January, this is your closing balance. The closing balance for January now becomes your opening balance for February, and your net income is added or subtracted accordingly. This process is repeated across the entire forecast period, with the final closing balance for the business carrying across to next year.

5. Revising, reviewing and analysing the results

Developing a cash flow forecast is just the first step. You must replace your predicted inflows and outflows with the actual figures each month to see how accurate your estimates were.

Did the results meet your expectations? If not, you may need to alter future forecasts to include new information and account for unexpected events.

6. Plan your business's cash flow future 

Your forecast should give you a good idea of how much cash on hand your business has, enabling you to plan more effectively for the future. Can you afford to invest in new technologies or staff based on your projections?

Perhaps now is the time to look at ways of reducing your business overheads and boosting sales? You may even need to consider finance options and other cash flow solutions if your forecast is giving you early warning signs.

Whatever the results, cash flow projections give you a better understanding of how financially prepared your business is – both now and for the future. This edge can mean the difference between success and failure as an SME.

If you need help with cash flow forecasts and other business advisory services, please book an appointment with WMC Accounting. We have comprehensive experience with budgeting, strategic planning and a wide range of other specialist offerings for growing businesses.