Why Cash Flow Forecasting Is Important: 7 Reasons

Ask business owners what keeps them up at night and cash comes near the top of the list. Yet many small businesses don’t forecast cash at all, relying instead on the bank balance and instinct. Here are seven reasons a simple cash flow forecast is one of the most valuable hours you can spend each month.

1. You see shortfalls before they happen

A forecast shows the week or month your balance will be lowest, often weeks or months ahead. That lead time is what makes problems solvable. With two months’ notice, a shortfall can be handled by chasing invoices, moving a purchase or arranging a facility. With two days’ notice, the options are late payments, expensive short-term borrowing or awkward phone calls.

Example: a business sees in October that January will fall $17,000 below its buffer, because a quiet month, a tax payment and an equipment purchase coincide. It moves the purchase to the summer. January passes without anyone noticing.

2. Decisions are based on evidence

Can we afford to hire? Should we buy the van now or in the spring? Can we take on this big contract? A forecast answers these with numbers rather than gut feel. Put the decision into the forecast, see what happens to the lowest balance, and decide.

3. Borrowing is easier and cheaper

Lenders ask for a cash flow forecast for almost every loan, overdraft and credit line. A business that already forecasts can respond quickly, explain its figures and show a track record of accurate forecasts. It can also arrange funding while things are calm, on better terms, rather than in a hurry. See what lenders look for.

4. Growth doesn’t become a cash trap

Growth uses cash: more staff, stock and materials are paid for before the extra customers pay. Profitable, fast-growing businesses are among the most likely to run short. A forecast shows how much working capital growth needs, so success doesn’t cause a crisis. See cash flow vs profit.

5. Tax money stays safe

Sales tax, VAT and payroll taxes sit in your bank account for weeks or months before they’re paid, making the balance look healthier than it is. A forecast puts every tax payment in the month it’s due, so that money isn’t spent by accident.

6. You’re ready for seasons and surprises

Seasonal businesses need to know how much of the busy season’s cash to keep for the quiet months. Every business benefits from knowing what a lost customer, a late payment or a cost increase would do. A forecast with a worst-case scenario turns those risks into plans. See also seasonal cash flow.

7. Less stress, better conversations

Knowing your cash position three months ahead is calmer than checking the bank balance every morning. A forecast also makes conversations with partners, staff, lenders and accountants more productive: everyone is looking at the same numbers.

A year with and without a forecast

Consider two similar service businesses, each with about $45,000 of monthly income, quarterly tax payments and a slow January.

Without a forecast, the owner notices in mid-January that the balance is low. A client’s payment is late, the tax bill is due and a new laptop order has just gone through. The owner delays paying a supplier, draws on a credit card at a high interest rate and spends a stressful fortnight chasing money. In March the same thing happens on a smaller scale.

With a forecast, the owner sees in October that January will be tight. They invoice the client’s December work on the day it’s finished, ask for a deposit on a January project, move the laptop purchase to February, and set aside part of December’s strong income. January is still the quietest month, but nothing is late, nothing is borrowed and no one notices.

The businesses are the same. The difference is a spreadsheet and fifteen minutes a month.

What happens without one

Businesses that don’t forecast usually find out about cash problems from the bank balance, which is the latest possible moment. The consequences are familiar:

• paying suppliers late and damaging relationships
• missing or delaying payroll
• tax penalties for late payment
• expensive emergency borrowing
• turning down good opportunities because the timing feels risky
• owners putting personal savings in at short notice
• decisions made on the bank balance alone, which says nothing about next month’s bills
• missed opportunities, such as supplier discounts for early payment, because nobody knew the cash was there

Why businesses don’t forecast

• “It’s too complicated.” A useful forecast needs five lines per month; a template does the arithmetic. See the beginner’s guide.
• “The future is unpredictable.” Most cash flow in the next few weeks is already known: invoices sent, bills scheduled, payroll fixed.
• “My accountant does that.” Accountants usually report the past. A forecast looks forward and needs your knowledge of the business.
• “I don’t have time.” Setting one up takes about an hour; keeping it current takes minutes a week.

Who benefits most

Every business benefits, but forecasting pays off fastest for businesses that invoice on credit terms, hold stock, have seasonal sales, are growing quickly, carry loans, employ staff on weekly or fortnightly payroll, or depend on a few large customers. If two or more of those describe you, a forecast will almost certainly change at least one decision in its first three months.

How to start

1. Download a template.
2. Enter today’s bank balance.
3. List expected receipts and payments by month, including tax and annual bills.
4. Look at the lowest month.
5. Update it each month with actual figures.

The full method is in how to make a cash flow forecast.

For growing businesses

As the business grows, add a 13-week weekly forecast, scenarios and actual vs forecast tracking. Premium industry templates include all three, plus the calculations your industry needs.