Preparing a short-term cash flow forecast

If, like many UK businesses, you are concerned about liquidity in the current crisis, assessing your cash position is a vital first step to understanding the extent and timing of any additional support you might need from lenders. Here’s how to initiate or improve your short-term cash flow forecasting process.

Cash flow is always a key factor of business survival and success, but in times of uncertainty the ability to manage and forecast cash flow becomes utterly critical for businesses of all sizes and sectors. Planning for future scenarios is especially difficult in the current pandemic, because there are still lots of unknowns about how lockdown easing will work, and because it’s hard to predict what life post-lockdown will look like for any business right now.

As the difficult economic conditions continue, many companies experiencing liquidity challenges will look to lenders for additional support or funding. Along with taking all necessary steps of your own to preserve cash and minimise funding requirements (such as freezing recruitment and cutting discretionary spend), another important step in this uncertain environment is to carry out a serious assessment of your cash position so you can accurately identify how much support you might require, and when.

1. How to use this guide

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In this article aimed at larger SMEs and Mid Corporates, we’ll walk you through the key elements of an effective short-term cash flow forecast. You can also use this guide to check whether your current cash flow forecasting process is accurate and robust.

Because the key cash and working capital drivers vary significantly between business types and sectors, we can’t provide an exhaustive list of points to review, of course, but instead we offer an overview of the key concepts and steps that any business will need to consider.

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2. Drivers of cash flow

Let’s start by getting to grip with the underlying drivers of cash flow in your business. To ensure you have a complete view, you will need to understand and document the sources of income and expenditure for the period of time that your forecast will cover.

The table below illustrates some of the basic forms, receipts and payments that a business may make, with some key factors to consider when forecasting. As you go through this list, think carefully about what information exists already, and which part(s) of the business can help to pull the forecast together.


Inflow/OutflowAreaCash flow typeInformation requirements & considerations
ReceiptsCustomerReceipts from invoiced sales
  • Aged debtor analysis and historic collection profiles or debtor days
  • Forecasting key or larger receivables separately from smaller receivables
 
Future sales (i.e. invoices sent to customers during the forecast period)
  • Sales forecasts and order books
  • Current performance to sales forecasts
  • Sales trends, including seasonality
 
OtherRental income
  • Contractual/actual receipt date and profile (i.e. monthly, quarterly)
 
Asset disposals
  • Has the disposal been made or is it a future disposal?
  • Expected date of completion
 
Other
  • Review historic bank statements for other receipts
 
PaymentsSuppliersPayment(s) made to suppliers for purchases already made and/or received by the business
  • Aged creditor analysis and creditor days
  • Accruals (e.g. goods received but not invoiced)
  • Supplier payment dates
  • Forecast critical or larger supplier payments separately from smaller suppliers
 
Future purchases (i.e. invoices received from suppliers for purchases made in the forecast period)
  • Sales forecast driving material requirements and purchases
  • Lead times and payment terms
  • Committed supplier orders
 
OtherCapital expenditure
  • Committed expenditure
  • Non-discretionary expenditure (i.e. linked to maintenance, health & safety)
  • Discretionary
 
Payroll
  • Salaries and wages, including overtime and other variable elements
  • Payroll frequency and payment dates
 
Overheads
  • Rents, rates and utility payments
  • Regular amounts, including direct debits and standing orders, including leases and HP
 
Taxation (e.g. PAYE, VAT and corporation tax)
  • Payroll
  • VAT return periods, payments on account and quarterly balances
 
Financing
  • Bank interest and repayments
 
Inflow/Outflow
Receipts
Area
Customer
Cash flow type
Receipts from invoiced sales
Information requirements & considerations
  • Aged debtor analysis and historic collection profiles or debtor days
  • Forecasting key or larger receivables separately from smaller receivables
 

Inflow/Outflow
Receipts
Area
Customer
Cash flow type
Future sales (i.e. invoices sent to customers during the forecast period)
Information requirements & considerations
  • Sales forecasts and order books
  • Current performance to sales forecasts
  • Sales trends, including seasonality
 

Inflow/Outflow
Receipts
Area
Other
Cash flow type
Rental income
Information requirements & considerations
  • Contractual/actual receipt date and profile (i.e. monthly, quarterly)
 

Inflow/Outflow
Receipts
Area
Other
Cash flow type
Asset disposals
Information requirements & considerations
  • Has the disposal been made or is it a future disposal?
  • Expected date of completion
 

Inflow/Outflow
Receipts
Area
Other
Cash flow type
Other
Information requirements & considerations
  • Review historic bank statements for other receipts
 

Inflow/Outflow
Payments
Area
Suppliers
Cash flow type
Payment(s) made to suppliers for purchases already made and/or received by the business
Information requirements & considerations
  • Aged creditor analysis and creditor days
  • Accruals (e.g. goods received but not invoiced)
  • Supplier payment dates
  • Forecast critical or larger supplier payments separately from smaller suppliers
 

Inflow/Outflow
Payments
Area
Suppliers
Cash flow type
Future purchases (i.e. invoices received from suppliers for purchases made in the forecast period)
Information requirements & considerations
  • Sales forecast driving material requirements and purchases
  • Lead times and payment terms
  • Committed supplier orders
 

Inflow/Outflow
Payments
Area
Other
Cash flow type
Capital expenditure
Information requirements & considerations
  • Committed expenditure
  • Non-discretionary expenditure (i.e. linked to maintenance, health & safety)
  • Discretionary
 

Inflow/Outflow
Payments
Area
Other
Cash flow type
Payroll
Information requirements & considerations
  • Salaries and wages, including overtime and other variable elements
  • Payroll frequency and payment dates
 

Inflow/Outflow
Payments
Area
Other
Cash flow type
Overheads
Information requirements & considerations
  • Rents, rates and utility payments
  • Regular amounts, including direct debits and standing orders, including leases and HP
 

Inflow/Outflow
Payments
Area
Other
Cash flow type
Taxation (e.g. PAYE, VAT and corporation tax)
Information requirements & considerations
  • Payroll
  • VAT return periods, payments on account and quarterly balances
 

Inflow/Outflow
Payments
Area
Other
Cash flow type
Financing
Information requirements & considerations
  • Bank interest and repayments
 

Factor in your current banking facilities

The liquidity position of the company includes both its cash flows and any available borrowing facilities. So to determine where you have any available headroom from your existing providers, your forecast needs to reflect all your current banking facilities and overdraft limits, and of course all current drawn amounts. To ensure that facilities will be available for the entire forecast period – and avoid the possibility of any unpleasant surprises – now is also the time to review facility expiry dates, drawing notice periods and any other restrictions that might be relevant.
Make sure you document all your available facilities as part of the forecast, as this data will form the basis for monitoring the use of forecast facility when considering both mitigating actions available to management (such as chasing outstanding invoices or deferring supplier payments) and any requests for external support.

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3. Key elements

If you already have some cash flow forecasting in place, how can you assess whether it is robust, accurate and fit for purpose in these most challenging times? How can you review or improve your process? You need to address these questions in the light of these five key areas, which we will look at in turn:

  • forecast set-up and control
  • forecasting timetable and frequency of preparation
  • forecast preparation, including anchor points and assumptions
  • challenge and review process
  • forecast reporting, including mitigating actions.

Set-up and control

The short-term cash flow forecast should be prepared on a simple receipts and payments basis rather than the sort of funds flow forecast that is used for longer-term forecasts. The former gives you a more granular and detailed analysis of the business’ cash flows, including variance analysis when monitoring the accuracy of the forecast. This line-by-line approach also enables cross-functional input and responsibility to be assigned for forecasting individual lines. So, for example, you can look at how forecasting movements in receivables (as you would in a funds flow forecast) can provide insight into when specific, larger customers will pay an outstanding invoice.

Prepare your forecast on a cleared funds basis rather than on a cash book basis (which shows only the current bank account balance, regardless of whether funds are cleared). This is the better approach because we are trying to forecast the bank account balance in order to compare this against available facilities. Forecasting on a cash book basis would require further reconciliation of outstanding receipts and payments.

Using a standard forecasting template, you can incorporate a monitoring process to review forecast accuracy via variance analysis – that is, comparing actual cash flows against forecast in order to review the appropriateness of underlying forecast assumptions. The template can follow a simple structure, with forecast receipts at the top followed by forecast payments, followed by the opening and closing cash balance for each week of the forecast, available facilities and headroom based on facility limit.

As forecasting is embedded into a business-as-usual finance process, instructions should be codified and requirements defined so as to mitigate the impact of staff changes and ensure the ongoing robustness of the forecast.

With larger businesses, cross-functional input may be required in order to improve forecast accuracy. Whilst finance and treasury manage the impact of business decisions on cash and working capital, for example, they may not control the underlying cash flow driver. So it’s vital that you have input from the very people who understand and control a particular cash flow – for example, input into the forecast via updated sales forecasts from commercial teams.

Where cross-functional input is in play, there may be a need for training and support, including providing forecasting templates, to help teams differentiate between the timing of the transaction and the associated cash flow arising from credit or payment terms.


Forecasting timetable

The short-term cash flow forecast should look forward over a period covering at least the next 13 weeks. Prepare it on a weekly basis so as to capture any intra-month volatility that could impact on the amount of any external support requested in terms of a month-end cash position. Each week the forecast rolls forward so as to maintain a minimum of 13 weeks of cash flows. Where cash flow is particularly tight, you may want to forecast on a daily basis for the first two or three weeks of the forecast period.

When the cash flow forecast is rolled forward, each of the underlying assumptions will need to be reviewed in light of the latest trading performance and conditions, and variances arising from a review of the accuracy of the previous weeks’ forecast.


Forecast preparation

The opening position of the short-term cash flow forecast should be anchored to the balance sheet. This should be a reconciled bank balance from the most recent balance sheet included in management reports. The cash flow forecast should also look to unwind current trade debtors, trade creditors and other key balance sheet items. Aged receivables and payables reports should help to forecast receivables and payables. Credit-control functions should be able to provide insight into the payment habits of customers who have been given credit terms and collection periods, as well as customers that are slow payers.

Forecasting larger customers separately from smaller customers may improve forecast accuracy as individual collection assumptions can be applied rather than overall averages. So too with trade creditors. When considering payments to suppliers, it may also be useful to segment suppliers that provide critical materials or services and/or are financially unstable. If, as part of the current financial difficulties, your business is already delaying some payments to suppliers, you will want to monitor the ageing of deferred invoices as this may impact on the ability to maintain supplies.

Review other balance sheet asset, liability and provision categories to ensure that all other likely cash flows are captured. These could include current liabilities relating to PAYE and VAT, as well as reviewing accrued expenses, such as where goods or raw materials have been received physically but no invoice has yet been received.

Each of the key assumptions used to prepare a line within the forecast should be documented, so that it can then be reviewed and evaluated using variance analysis.


Challenge and review process, including variance analysis and scenario planning

Variance analysis allows you to monitor the accuracy of the cash flow forecast and to determine whether you need to update any underlying assumptions; as such, it needs to be performed on every individual line of the forecast. Analysing only the closing cash position or the net cash flow for the week (i.e. the difference between total receipts and total payments) could hide forecasting weaknesses and give a misleading output as a result of offsetting variances in other areas of receipts and payments.

As this is a working document, the forecast must be updated and rolled forward on a weekly basis so as to continue to provide a reasonable view of liquidity in the business. Variances to the forecast can then be classified as either timing differences or permanent differences. Timing differences will lead to a re-phasing of the cash flow forecast (i.e. moving the cash flow to an alternative week of the forecast). Permanent variances mean that the underlying assumption needs to be modified.

There’s no doubt that the accuracy of the cash flow forecast will become less reliable as the time period is extended. Whilst this is to be expected of any forecasting process, it will be helpful to know at what point performance deviates, and in what ways. For example, are sales forecasts too optimistic or have supplier payments relating to future purchases been understated, so leading to an overstated cash position in the later weeks of the forecast?

In order to assess any specific trends in the forecasting, you might consider tracking an initial cash flow forecast and comparing this entire forecast to actual cash flows and closing balances. Care should be taken when doing this, however, as mitigating actions, such as delaying supplier payments in order to manage to a cash target, may distort actual cash flows.

Variance analysis between forecasts should also be prepared to understand whether key movements between forecast iterations, such as a change in the weekly closing cash position, can be considered reasonable. Analysis of forecast versus reforecast variance, including bridging between forecasts, should help account for such changes. Where there is external monitoring of cash flow forecasts, this is a key output or commentary that will often be requested.


Scenario planning

Understanding the cash profile of the business is critical during this period. Available liquidity can change rapidly as the business faces a range of operational challenges. Ensuring the business maintains an updated view of its cash forecast is essential, as this will determine when to implement any mitigating actions.

As each of the key assumptions are reviewed, appropriate sensitivities should be considered, such as:

  • actual trading performance, where this is different to planned performance
  • impact of key customers not able to pay outstanding invoices
  • impact of credit insurers amending cover
  • your ability to meet existing orders and to get paid, based on whether suppliers can continue to provide you with raw materials
  • impact of changes to sales pipelines and demand
  • longer-term inventory planning and product range changes where there is insufficient stock to continue production and supply.

Potential cash-generating initiatives

Any cash-generating initiatives that the business is considering should be seen as integral to performance improvement measures. Mitigating actions can help to reduce and/or delay any request for external support. These initiatives should be assessed, prioritised and progressed at appropriate speeds. While none of these potential options will be without consequences, it is important to understand when you need to implement the prioritised list as liquidity can change rapidly.

Finally, senior finance leadership should review and approve the forecast, including sensitivity analysis and mitigating actions, before it is issued to the business or external stakeholders.


Forecast reporting, including mitigating actions

A short-term cash flow forecast is only useful if its inputs and implications are fully understood. To that end, always make sure to circulate the forecast accompanied by:

  • documented assumptions
  • detailed commentary, including key forecast movements, variance analysis against actual performance, and changes from previous forecasts
  • an overview of the impact on the short-term cash flow and available headroom of risks, sensitivities and potential future opportunities.

While finance functions play a critical role in the preparation of a cash flow forecast and will understand it more than other areas of the business, it is important for all directors of a company to be informed about the cash position of the business. If cash is not seen as a priority by the senior leadership team, after all, it is unlikely it will become a business priority. But if senior leadership are proactive in asking for and reviewing cash flow forecasts and information, this will force the business to produce robust, timely management information.

A company that understands its cash and liquidity position, including potential risks, and has a robust process in place to understand and manage these resources, will be better able to control its own destiny. A disciplined focus on cash flow forecasting will be vital in the coming months ahead.

Beyond this though, finding alternative revenue streams is well worth the effort. It’s far from the ideal circumstance in which to do so, but even now, a lot of the standard tips on how to develop and launch a new product still hold. Timeframes are shorter and markets are narrower, but there are opportunities to pursue if you can.

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4. Further support

Need support during coronavirus?

For more information about the advice and support that is available to businesses from the government, Lloyds Bank and other sources, see our dedicated coronavirus business information page.

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