green background banner image

Forecasting and Managing Cashflows

  • Cash flow- the sum of cash payments to a business (inflows) less the sum of cash payments (outflows)
  • Liquidation- when a firm ceases trading, and its assets are sold for cash to pay suppliers and other creditors
  • Insolvent- when a business cannot meet its short-term debts


  • New business start-ups are often offered much less time to pay suppliers than larger, well-established firms – they are given shorter credit periods
  • Banks and other lenders may not believe the promises of new business owners as they have no trading record, they will expect payment at the agreed time
  • Finance is often very tight at start-up, so not planning accurately is of even more significance for new businesses


  • Cash (also called revenue) refers to the amount of money currently/soon-to-be available to the business
    • Cash is always important – short and long term
    • Cash flow relates to the timing of payments to workers and suppliers and receipts from customers. If a business does not plan the timing of these payments and receipts carefully it may run out of cash even though it is operating profitably
    • Cash inflows- payments in cash received by a business, such as those from customers (trade receivables) or from the bank, for example receiving a loan
    • Cash outflows- payments in cash made by a business, such as those to suppliers and workers.
  • Profit is the amount of money left over after all expenses have been paid
    • Profit does not pay the bills and expenses of running a business, but profit is important – especially in the long term when investors expect rewards, and the business needs additional finance for investment


  • Forecasting cash flow means trying to estimate future cash inflows and cash outflows, usually on a month-by-month basis
  • Examples of forecasting cash inflows-
    • Owner’s own capital injection- this is easy to forecast as it is under the entrepreneur’s direct control
    • Bank loan payments- this will be easy to forecast if they have been agreed with the bank in advance, both in terms of amount and timing
    • Customers’ cash purchases- this will be more difficult to forecast as they depend on sales
    • Trade receivables payments- these will be difficult to forecast as these depend on two unknowns
      • What is the likely level of sales on credit
      • When will trade receivables actually pay
  • Examples of forecasting cash outflows-
    • Lease payment for premises – easy to forecast as this will be in the estate agent’s details of the property.
    • Annual rent payment – easy to forecast as this will be fixed and agreed for a certain time period. The landlord may increase the rent after this period, however.
    • Electricity, gas, water, and telephone bills – difficult to forecast as these will vary with so many factors, such as the number of customers, seasonal weather conditions and energy prices.
    • Labour-cost payments – these forecasts will be based largely on demand forecasts and the hourly wage rate that is to be paid. These payments could vary from week to week if demand fluctuates and if staff are on flexible contracts.
    • Variable cost payments such as cleaning materials – the cost of these should vary consistently with demand, so revenue forecasts could be used to assess variable costs too.


  • Cash-flow forecast- estimate of a firm’s future cash inflows and outflows
  • All cash-flow forecasts have three basic sections:
    • Section 1 – Cash inflows: This section records the cash payments to the business, including cash sales, payments for credit sales and capital inflows.
    • Section 2 – Cash outflows: This section records the cash payments made by the business, including wages, materials, rent and other costs.
    • Section 3 – Net monthly cash flow and opening and closing balance: This shows the net cash flow for the period and the cash balances at the start and end of the period – the opening cash balance and the closing cash balance. If the closing balance is negative (shown by a figure in brackets), then a bank overdraft will almost certainly be necessary to finance this.
      • Net monthly cash flow- estimated difference between monthly cash inflows and cash outflows
      • Opening cash balance- cash held by the business at the start of the month
      • Closing cash balance- cash held at the end of the month becomes next month’s opening balance


  • There are several important advantages to cash-flow forecasting, especially for new businesses
  • By showing periods of negative cash flow, plans can be put in place to provide additional finance, for example arranging a bank overdraft or preparing to inject more owner’s capital.
  • If negative cash flows appear to be too great, then plans can be made for reducing these – for example, by cutting down on purchase of materials or machinery or by not making sales on credit, only for cash.
  • A new business proposal will never progress beyond the initial planning stage unless investors and bankers have access to a cash-flow forecast and the assumptions that lie behind it.


  • Mistakes can be made in preparing the revenue and cost forecasts or they may be drawn up by inexperienced entrepreneurs or staff
  • Unexpected cost increases can lead to major inaccuracies in forecasts- fluctuations in oil prices can lead to the cash-flow forecasts of even major airlines being misleading
  • Wrong assumptions can be made in estimating the sales of the business, perhaps based on poor market research, and this will make the cash inflow forecasts inaccurate


  • Lack of planning
    • Cash-flow forecasts help greatly in predicting future cash problems for a business. This form of financial planning can be used to predict potential cash-flow problems so that business managers can take action to overcome them in plenty of time- without cash-flow forecasts, businesses lack guidance for their financial planning
  • Poor credit control
    • The credit-control department of a business keeps a check on all customers’ accounts – who has paid, who is keeping to agreed credit terms and which customers are not paying on time. If this credit control is inefficient and badly managed, then trade receivables will not be ‘chased up’ for payment and potential bad debts will not be identified.
  • Allowing customers too long to pay debts
    • In many trading situations, businesses will have to offer trade credit to customers in order to be competitive. Customers are likely to go for credit terms because it helps them to improve their cash flow. However, allowing customers too long to pay means reducing short-term cash inflows, which could lead to cash-flow problems.
  • Expanding too rapidly
    • When a business expands rapidly, it has to pay for the expansion and for increased wages and materials months before it receives cash from additional sales. This overtrading can lead to serious cash-flow shortages – even though the business is successful and expanding.
  • Unexpected events
    • A cash-flow forecast can never be guaranteed to be 100% accurate. Unforeseen increases in costs – a breakdown of a delivery van that needs to be replaced, or a dip in predicted sales income, or a competitor lowering prices unexpectedly – could lead to negative net monthly cash flows.


  • There are two main ways to improve net cash flow- increase cash inflows and reduce cash outflows
    • Increasing cash inflows-
      • Overdraft- flexible loans on which the business can draw as necessary up to an agreed limit; however, interest rates can be high and there might be an overdraft arrangement fee; overdrafts can be withdrawn by the bank and this often causes insolvency
      • Short-term loan- a fixed amount can be borrowed for an agreed length of time; however, interest costs have to be paid and the loan must be repaid by the due date
      • Sale of assets- cash receipts can be obtained from selling off redundant assets, which can boost cash inflow; however, selling assets quickly can reduce in a low a price; the assets might be required by the business at a later date for expansion; the assets could have been used as collateral for future loans
      • Sale and leaseback- assets can be sold, for example to a finance company, but the asset can be leased back from the new owner; however, the leasing costs add to annual overheads; there could be loss of potential profit if the asset rises in price; the assets could have been used as collateral for future loans.
  • Reduce credit terms to customers- cash flow can be improved by reducing credit terms, for example for two months to one month; however, customers may purchase products from firms that offer extended credit terms
    • Debt factoring- debt-factoring companies can buy the customers’ bills from a business and offer immediate cash – this reduces risk of bad debts too; however, only about 90–95% of the debt will now be paid by the debt factoring company – this reduces profit; the customer has the debt collected by the finance company – this could suggest that the business is in trouble.
    • Reducing cash outflows-
      • Delay payments to suppliers/creditors- cash outflows will fall in the short term if bills are paid, for example after three months instead of two months; however, suppliers may reduce any discount offered with the purchase; suppliers can either demand cash on delivery or refuse to supply at all if they believe the risk of not being paid is too great.
      • Delay spending on capital equipment- by not buying equipment, vehicles, etc. cash will not have to be paid to suppliers; however, the efficiency of the business may fall if outdated and inefficient equipment is not replaced; expansion becomes very difficult.
      • Use leasing instead of purchasing capital equipment- the leasing company owns the asset, and no large cash outlay is required; however, the asset is not owned by the business, and leasing charges include an interest cost and add to annual overheads.
      • Cut overhead spending that does not directly affect output- these costs will not reduce production capacity and cash payments will be reduced; however, future demand may be reduced by failing to promote the products effectively.


  • Not extending credit to customers or extending it for shorter time periods: Will they still buy from this business? Will a major aspect of this business’s marketing mix have been removed?
    • Evaluation of this approach: Many customers now expect credit and will go elsewhere if it is not offered- the marketing department might argue for an increase in credit terms to customers at the same time as the finance department is trying to cut down on them.
  • Selling claims on trade receivables to specialist financial institutions acting as debt factors: These businesses will ‘buy’ debts from other concerns that have an immediate need for cash.
    • Evaluation of this approach: This will involve a cost, however as the factors will not pay 100% of the value – they must make a profit for themselves.
  • By being careful to discover whether new customers are creditworthy: This can be done by requiring references – from traders or from the bank is common, or by using the services of a credit enquiry agency.
  • By offering a discount to clients who pay promptly: Although cash might be paid quickly, discounts reduce the profit margin on a sale.


  • Increasing the range of goods and services bought on credit: If a business has a good credit rating, this may be easy, but in other circumstances it is difficult.
    • Evaluation of this approach: The danger is that an unpaid creditor may refuse to supply, and this will cause production hold-ups. In addition, discounts from suppliers for quick cash payment might be given up.
  • Extend the period of time taken to pay: The larger a business is, the easier it is to extend the credit taken. This will improve the larger firm’s working capital.
    • Evaluation of this approach: Slow payment by larger businesses is often a great burden for small businesses that supply them. Suppliers may be reluctant to supply products or to offer good service if they consider that a business is a ‘late payer’.