Are you embarrassed by your lack of financial knowledge? It’s OK if you are but the best thing to do is acknowledge it and start taking steps to improve it. If you were going on a fitness journey, you wouldn’t try to run a marathon the first day. You would slowly build up to it. Similarly, your finance journey begins with small steps.
Key Financial Statements
If I was a business owner and wanted to learn about how my business was performing, there are a few places to start. There are 3 key financial statements:
- Balance Sheet
- Income Statement
- Cash Flow statement
The balance sheet tells you about the financial health of your company as of a particular date. The income statement (aka profit and loss) informs you about the income and expenses of your company during a particular period of time (usually a month, quarter or year). The cash flow statement details how you received and spent cash.
Cash Forecast
However, if I wanted to know how my business is performing, I would not look at any of these 3 statements. The first thing any business needs to worry about is its cash forecast. It is possible for a company to be very profitable but go out of business because it does not have enough cash to pay its bills. Conversely, it is possible for a company to be unprofitable but have a lot of cash on hand. The reasons for this is beyond the scope of this post but for now just believe me when I say it.
I mentioned above that the 3 key financial statements are prepared once a month or less frequently. However, well run businesses prepare cash forecasts at least weekly and in many cases daily. That is how critical it is. The good news is that it can be easy to prepare and the process of preparing it gives you a lot of insights into your business.
Cash Forecast Frequency
Before you start preparing cash forecasts, you need to decide how often you will prepare the forecast and how detailed the forecast will be. Large businesses prepare long and short term cash forecasts.
A long term forecast may be an annual forecast for 5 years. For example, in 2025 they may have a monthly cash forecast but an annual forecast for 2026 to 2029. Annual forecasts are not updated frequently because if income is higher in January but lower in February, there is no change to the annual forecast so it is a waste of time to update it. For businesses with very little cash, forecasts should be prepared at least once a week or even daily. I have never worked for a business that did not prepare cash forecasts at least once a week.
The purpose of a cash forecast is to ensure that you have cash available when it is required. If your forecast shows that you will not have enough cash to pay rent when it is due, at least you are aware of it before rent day. This gives you time to look for other options. You can call the landlord to make arrangements, you can ask the bank for a loan, you can try to delay other payments if you have suppliers that will work with you. Even if you don’t have the cash to pay your bills, it should not be a surprise. Your forecast should have shown you that weeks or months before the due date.
Cash Flow Forecast Detail
Once you know how often you will prepare your forecast, you need to decide how detailed your forecast will be. Your forecast will track cash coming into and going out of your business. You can track income and expenses by category or by customer and supplier. For example, if your company only has 5 customers, you could track income by customer. If you have 100 suppliers, you could track expenses by category.
What is important is to be able to easily identify the problem when the actual cash diverges from the forecast. If your forecast is too detailed, it takes longer to prepare and it is easier to make errors. If it is too summarized, it can be difficult to recognize problems. This will be come clearer when we do an example below.
How to Prepare a Cash Forecast
It is best to prepare your forecast in a spreadsheet because the numbers will be constantly changing and you do not want to have to update the calculations manually. Your spreadsheet does not have to be very complicated. Start listing the cash inflows you expect. Next list the cash outflows.
It is important to remember that a cash forecast does not have anything to do with income and expense. Cash inflows are not necessarily income and outflows are not necessarily expenses. The forecast is not concerned with how the cash is treated for accounting purposes. It is only forecasting what happens to the bank accounts.
Let’s say you have 3 customers and you expect to receive $1,000 from each next week. You would forecast $3,000 cash inflow for next week. Let’s also assume you do not have any bills due next week so your outflow forecast is $0. Your forecast would show a $3,000 cash increase.
Updating a Cash Forecast
Following on from the example above, let’s assume you started the week with $5,000 in the bank. According to the forecast, you should end the week with $8,000 in the bank (with the $3,000 increase). If you end the week with $8,000, your work is not complete. You still need to review the details. For example, what if one of your customers paid $2,000 and one did not pay anything. You need to understand what happened. Did you have more sales than expected from the customer that paid $2,000? Did the customer that did not pay anything not have any sales or is the payment late? This understanding will help you to update your next forecast.
Learnings from Cash Forecasts
By reviewing your cash forecasts, you learn where cash flow does not match your expectations. This will help you identify trends early so you can take corrective action. Since you should be performing cash forecasts at least once a week, you may discover pleasant or unpleasant surprises before preparing the income statement at the end of the month.
Conclusion
The first finance metric that a business owner should monitor is the company’s cash position. A good cash forecast will highlight issues with the business before it shows up in the financial statements. This can give the business owner time to make adjustments at the earliest time possible.