Being able to predict its cashflow is vital for every small and medium-sized enterprise (SME). It enables them to project how much money will come into and go out of a business over a defined period, and, therefore, budget accordingly for their future.
By carrying out a cashflow forecast, a firm can determine their financial position far more accurately than by any other means. As a result of being able to see how the enterprise is performing, leaders can make far more informed decisions and plan for the future, whether that’s to borrow or invest more to grow the business, as well as to find new opportunities to capitalise on. The end result is that the operation runs far more smoothly and effectively.
Cashflow forecasting’s role can’t be underestimated, particularly in light of the fact that 90% of UK businesses fail due to cashflow problems, according to the Office for National Statistics. That’s because many’s cash reserves dry up as they find debtors and creditors hard to predict and they carry too much stock, which could be easily overcome by producing an accurate cashflow forecast.
But in order to successfully make a cashflow forecast, first companies must have good quality and reliable data to hand. They can then analyse that data in order to make their projections.
Cashflow forecasting
It’s essential to carry out regular cashflow forecasts, ideally for one, three and five years, as they can change significantly over time, depending on incomings and outgoings. That way, SMEs can identify any shortfalls they need to plug, spending that should be reduced or surplus cash that can be put to better use in other parts of the business. It’s also critical in terms of borrowing, given that most lenders will expect to see a 12-month cashflow forecast for the business before deciding whether to offer them a loan.
Cashflow forecasting is the most important of the five main types of forecasting. It’s done by looking at revenue (money coming in) and expenses (costs incurred), and then working out the net cashflow (the difference between the two).
Data is key
That’s where data comes in. The company needs to look at every aspect of the business, including variables such as terms of payment, incentives to get people to pay on time, the time taken between finishing a job and getting paid, and seasonality. It must also consider its most significant outlays, including payroll, rent or mortgages, inventory, supplies, tax obligations and any large upgrades of machinery or equipment.
Scenario modelling
Cashflow forecasting is modelled on different types of scenarios. The three main ones are the base case, the worst case and the best case scenario.
The best case may include the most favourable economic conditions, and the highest possible revenue growth and lowest possible expenditure and rates. The worst case is the opposite: based on the highest possible interest rates, inflation rate and discount rate, and input pricing. The base case is derived from a business-as-usual cashflow forecast.
Future forecasting
There are many online financial forecasting tools readily available that can provide accurate cashflow projections based on data from a company’s accounting software and databases. It’s a matter of first figuring out which one will work best for a particular business.
Given the current adverse and uncertain economic climate, it has never been more important to be able to accurately forecast cashflow. That will put SMEs on a far stronger financial footing to continue to thrive and weather any future economic shocks.
Chirag Shah, founder and CEO of Nucleus Commerical Finance and Pulse.io has over 20 years of experience in the financial services industry and a deep understanding of the needs of UK SMEs.
In 2011, he founded Nucleus, a leading alternative finance provider, to offer flexible and tailored solutions for SMEs across various sectors and stages of growth. With an understanding of the challenges that UK SMEs face in the current economic climate, Chirag launched Pulse in October 2022, a free-to-use service that helps businesses and accountants gain insights into financial performance with AI-powered data visualisation and personalised dashboards. Chirag is not only committed to driving growth and innovation in the UK business ecosystem, but he’s also helping SMEs better understand their data to boost their profitability and guide them towards success.
