Cash Flow Forecasts

A cash flow forecast is a prediction of the anticipated cash inflows and cash outflows, usually for a six to twelve month period
A detailed business plan should include a cash flow forecast that allows the business owners to identify its financial needs

Key terminology and an example

The net cash flow is calculated by subtracting total cash outflows from total cash inflows
The opening balance is the previous month’s closing balance carried forward
The closing balance is calculated by adding the net cash flow to the opening balance

An Example of a Start-up Six-month Cash Flow Forecast (£s)

	Jan	Feb	Mar	Apr	May	Jun
Inflows
Cash received from sales	2,600	2,800	3,100	4,600	4,800	5,200
Capital introduced	6,000	0	0	0	0	0
Total inflows	8,600	2,800	3,100	4,600	4,800	5,200
Outflows
Inventory	1,500	850	950	1,300	1,350	1,400
Wages	2,200	2,200	2,200	2,200	2,200	2,200
Utilities	840	840	840	882	882	882
Loan repayments	0	284	284	284	284	284
Miscellaneous	230	240	250	410	260	260
Total outflows	4,770	4,414	4,524	5,076	4,976	5,026
Net cash flow	3,830	(1,614)	(1,424)	(476)	(176)	174
Opening balance	500	4,330	2,716	1,292	816	640
Closing balance	4,330	2,716	1,292	816	640	814

Analysis of the cash flow forecast example

Executive Summary

Overall, this cash flow forecast supports an application for the business to borrow £6,000 in January to cover the initial low inflows, significant outflows and negative net cash flow
As sales increase from June, inflows are greater than outflows and the business has a positive cash flow
Should a loan be approved, the business will require any short-term sources of finance such as overdraft facilities

January

The cash flow forecast assumes that the bank approves a £6,000 loan in January (capital introduced)
The opening balance of £500 has been introduced by the owner
The business is expected to achieve sales of £2,600
Total inflows are therefore expected to be £8,600 (£2,600 + £6,000)
Total outflows are expected to be £4,770
The Net Cash Flow is expected to be £3,830 (£8,600 - £4,770)
January’s closing balance is expected to be £4,330 (£3,830 + £500)

February

The closing balance from January becomes the opening balance for February
Sales of £2,800 as expected to be the business total inflows
Total outflows are expected to be £4,414
The Net Cash Flow is expected to be -£1,614 (£2,800 - £4,414)
The closing balance is expected to be £2,716 (-£1,614 + £4,430)

June

The closing balance from May becomes the opening balance for June
Sales of £5,200 are the business total inflows
Total outflows are expected to be £5,026
The Net Cash Flow turns positive and is expected to be £174 (£5,200-£5,026)
The closing balance is expected to be £814 (£174 + £640)

Worked example

Here is a simple three-month cash flow forecast for a small seaside café

	March	April	May
Inflows
Sales	46,000	54,000	61,000
Outflows
Inventory	13,000	13,000	13,000
Wages	28,000	28,000	28,000
Miscellaneous	3,500	4,000	4,000
Total Outflows	44,500	45,000	45,000
Net cash flow	1,500	9,000	16,000
Opening balance	4,000	5,500	14,500
Closing balance	5,500	14,500	30,500

The café owner thinks that good weather will increase the volume of customers and decides to appoint another full-time assistant in March. As a result, wages increase to an expected £31,000 per month

Calculate the closing balances in the cash flow forecast resulting from the changes above. [4]

	March	April	May
Inflows
Sales	46,000	54,000	61,000
Outflows
Inventory	13,000	13,000	13,000
Wages	31,000	31,000	31,000
Miscellaneous	3,500	4,000	4,000
Total Outflows	47,500	48.000	48,000
Net cash flow	(1,500)	6,000	13,000
Opening balance	4,000	2,500	8,500
Closing balance	2,500	8,500	21,500

Step 1: Insert the value of the new wages into the relevant space for each month

Step 2: Calculate the new total outflows for each month and insert them into the relevant space for each month

- March: £13,000 + £31,000 + £3,500 = 47,500
- April: £13,000 + £31,000 + £4,000 = 48,000 [1 mark]
- May: £13,000 + £31,000 + £4,000 = 48,000

Step 3: Calculate the new net cash flow for each month and insert it into the relevant space for each month

- March: £46,000 - £47,500 = -£1,500
- April: £54,000 - £48,000 = £6,000 [1 mark]
- May: £61,000 - £48,000 = £13,000

Step 4: Calculate and insert the new closing balance for March and carry it forward as the opening balance for April

- £4,000 + - £1,500 = £2,500 [1 mark]

Step 5: Calculate and insert the new closing balance for April and carry it forward as the opening balance for May

- £2,500 + £6,000 = £8,500 [1 mark]

Step 6: Calculate and insert the new closing balance for May

- £8,500 + £13,000 = £21,500 [4 marks for the correct answer]

Note that this one change in the anticipated cost of wages impacts four other variables 1.Total outflows 2. Net cash flow 3. Opening balance (except March) 4. Closing balance

Exam Tip

When calculating opening and closing balances, work through each month in turn.

Always double-check your calculations in cash flow forecasts as one mistake will have a knock-on effect elsewhere and, in some cases, lead you to make inaccurate judgements.

Evaluating Cash Flow Forecasts

Cash flow forecasts provide insights into the expected inflows and outflows of cash over a specific period
By analysing these forecasts over time, businesses can better plan and allocate their financial resources
It is also important to recognise that cash flow forecasts have limitations

The Uses & Limitations of Cash Flow Forecasts

Advantages

Disadvantages

Cash flow forecasts can support an application for a loan and are an integral part of the business plan

They can help identify where the business may experience cash shortfalls or cash surpluses so that plans can be made to manage these periods (e.g. arranging an overdraft)

Cash flow forecasts aid planning and help a business avoid costly mistakes

Forecasts are usually based on estimates and in reality inflows and outflows may differ significantly from the estimates

Cash flow forecasts require appropriate skills, insight, research and time to prepare and update adequately

External factors that can impact inflows and outflows may not be reflected in the cash flow forecast

Exam Tip

Look for clues in the case study about the reliability of the forecast and draw some judgments on the reliability of the forecast presented.

New entrepreneurs find it especially difficult to create accurate forecasts as they have little experience to draw on. They often make use of free advice and guidance (e.g. from banks) or conduct significant research to support their forecasts. In these cases, the cash flow forecast is likely to be an excellent tool for planning. Where the cash flow forecast is constructed without such care it can hinder business progress and can undermine the business plan as a whole.

Cash Flow Forecasts (HL IB Business Management)

Revision Note