A cash flow forecast can show you when money could get tight, often before it happens. Here’s how to build one and use it to make better decisions.

A business can be profitable and still run out of cash.

That's one of the hardest things for a new business owner to get their head around. You can have plenty of sales, invoices waiting to be paid and a healthy-looking profit on paper, but if the money isn't in your bank account when the bills are due, you've got a problem.

That's where a cash flow forecast comes in.

It isn't about predicting the future perfectly. It's about having a realistic view of how much money is likely to come into and leave your business over the weeks and months ahead.

Done properly, it can give you an early warning that cash is going to get tight, as well as showing you when you may have money available to invest in the business.

What is a cash flow forecast?

A cash flow forecast is a forward-looking estimate of the money coming into and going out of your business over a set period.

It normally starts with the amount of cash you have available today. You then add the money you expect to receive and take away the payments you expect to make.

The result is your projected cash balance.

For example, if you start the month with £20,000 in the bank, expect £15,000 of customer payments and have £18,000 of bills and other payments due, your forecast would show £17,000 remaining at the end of the month.

The important thing is when the money actually moves.

If you've invoiced a customer £10,000 but they don't pay for 60 days, that £10,000 shouldn't be treated as cash you have available today.

Why do small businesses need a cash flow forecast?

The biggest benefit is that it gives you time to spot problems.

If your forecast shows that your bank balance could fall below the level you need to cover your bills in six weeks' time, you have six weeks to do something about it.

You might chase unpaid invoices, negotiate a payment date with a supplier, reduce spending, delay a purchase or arrange finance.

Without a forecast, you may not realise there's a problem until a payment is due and the money isn't there.

A forecast can also help with growth. If you're thinking about taking on an employee, buying equipment, opening another site or increasing stock, you can see how the extra spending could affect your cash position before you commit.

How far ahead should you forecast?

There's no single answer that works for every business.

A 12-month forecast can give you a useful overview of the year ahead, particularly if your business has seasonal peaks and quieter periods.

But the further ahead you look, the less certain the numbers become.

That's why it can help to combine a longer-term forecast with a more detailed short-term view. For example, you might have a 12-month forecast but keep a particularly close eye on the next 13 weeks.

If cash is tight, a weekly forecast can give you much more useful information than simply looking at the next year's expected sales.

Start with your opening cash balance

The first number you need is how much cash the business actually has available at the start of the forecast period.

Use your real bank balance rather than an estimate.

If you have money that isn't immediately available to spend, such as funds held in a separate account or money already set aside for tax, be clear about whether it should be included.

The aim is to show the cash you can realistically use.

List all the money coming in

Next, work out what cash you expect to receive.

This could include customer payments, cash sales, online sales, loans or other finance, grants, investment, tax refunds or other one-off receipts.

The key is to record when you expect to receive the money, not simply when you've made the sale.

For example, if you invoice a customer on 1 June with 30-day payment terms, the cash may not arrive until July.

And be realistic about late payments. If customers regularly pay invoices a few weeks late, your forecast should reflect that rather than assuming everyone pays exactly on time.

Then list everything going out

Now do the same for payments.

Include your regular costs such as wages, rent, utilities, insurance, software subscriptions, loan repayments, supplier payments, stock, advertising, professional fees, tax, VAT, business rates and equipment.

Don't forget one-off or less frequent costs.

An annual insurance payment, tax bill or equipment purchase can make a big difference to your cash position in the month it is paid.

Don't confuse profit with cash

This is one of the most important points.

Profit and cash are not the same thing.

If you make a £20,000 sale and invoice the customer, that may count as revenue even though the £20,000 hasn't reached your bank account yet.

Likewise, buying an expensive piece of equipment can have a big impact on your bank balance even though the accounting treatment may be different.

A cash flow forecast is concerned with the actual movement of money.

That's why a business can show a profit and still have a cash flow problem.

Build in your tax payments

Tax is one of the easiest things for a business owner to underestimate when looking at cash flow.

Depending on your business structure and circumstances, you may have payments including VAT, PAYE, Corporation Tax or Self Assessment.

Don't wait until the payment is due to think about it.

Put the expected payment into your forecast in the month you expect the money to leave the business.

If you're not sure when your tax payments are due or how much to allow for, speak to your accountant or check your HMRC account.

Think about seasonality

Your business may not earn the same amount every month.

A retailer could have a much stronger December than February. A hospitality business might have busy summer months and quieter periods in winter. A business selling to schools could have its own seasonal pattern.

Your forecast should reflect what happens in your business.

Using the same sales figure every month might make the spreadsheet look tidy, but it won't necessarily make the forecast useful.

Look at previous years if you have them and consider anything you already know about the year ahead.

Be realistic about your sales

This is where forecasts can go wrong.

It's tempting to put in the sales you'd like to make rather than the sales you're likely to make.

If you have signed contracts or regular customers, those are relatively easy to forecast.

Potential customers, unconfirmed orders and hoped-for growth are different.

It can help to build different scenarios rather than relying on one number.

For example, you could have a base case, a stronger sales scenario and a weaker sales scenario.

That way, you can see how much cash you might have under different outcomes.

Don't forget unpaid invoices

Money you're owed isn't the same as money in the bank.

If customers regularly take longer to pay, that can create a gap between making a sale and having the cash available.

Keep an eye on your outstanding invoices and make sure your forecast reflects your actual payment history.

Chasing overdue invoices isn't just an admin task. It can be an important part of managing your cash flow.

Work out your closing cash balance

Once you've added your expected income and payments, you can calculate your projected closing cash balance.

The basic calculation is:

Opening cash + money coming in – money going out = closing cash

That closing figure then becomes the opening cash balance for the next period.

The important number isn't simply whether the business ends the year with more cash than it started with.

Look at the lowest point during the year.

A business can finish December with £30,000 in the bank but still face a serious problem if its cash balance falls to £2,000 in October and it has £10,000 of bills due.

Give yourself a cash buffer

Your forecast should help you think about how much cash the business needs to keep available.

There isn't a universal figure that every business should hold. It depends on your costs, how predictable your income is and how quickly you could cut spending if sales fell.

The more unpredictable your income and the higher your fixed costs, the more important a cash buffer becomes.

The forecast can help you work out what that buffer might need to look like.

Update your forecast regularly

A cash flow forecast isn't something you create once and put in a folder.

Actual sales will be different from your estimates. Customers will pay late. Bills will change. New costs will appear.

Update the forecast regularly using what has happened.

For a business with tight cash flow, that might mean looking at it every week. For a more established business with predictable income and costs, a monthly review may be enough.

The important thing is to use it as a live financial tool rather than a document you only look at when the bank balance starts to worry you.

What are the most common cash flow forecasting mistakes?

One of the biggest mistakes is overestimating sales.

Another is assuming customers will pay on time when they don't normally do so.

It's also easy to forget annual or irregular bills, underestimate tax or leave out spending on equipment, stock or repairs.

And don't make the forecast unnecessarily complicated.

A simple forecast based on sensible assumptions is far more useful than a huge spreadsheet full of figures that nobody updates.

What should you do if the forecast shows a cash shortfall?

Don't wait until the money has run out.

If your forecast shows a potential shortfall, you have options - and the earlier you spot it, the more options you have.

You could chase overdue invoices, ask customers for deposits or shorter payment terms, negotiate payment terms with suppliers, reduce discretionary spending or delay non-essential purchases.

Depending on the situation, you might also look at business finance or other sources of funding.

The key is to understand why the shortfall is happening.

A temporary gap caused by a large annual bill is very different from a business that is consistently spending more cash than it generates.

A cash flow forecast is there to help you make decisions

You don't need to be an accountant to create a useful cash flow forecast.

At its simplest, it's a way of answering one important question:

Will the business have enough cash to pay its bills when they are due?

Once you can see that clearly, you can make better decisions about spending, hiring, stock, investment and finance.

The forecast won't tell you exactly what will happen.

It gives you something more useful: time to prepare for what might happen next.