What SMEs need to know about cash flow forecasting in a growth phase

As an SME business owner, growth is likely to be at the forefront of your mind. But to fuel that growth, you need a healthy cash flow. That’s because cash is required to pay for expansion efforts like hiring more staff, purchasing new inventory, running marketing campaigns, investing in new technology, and more.

Cash flow measures how much cash is coming into your business (usually from sales revenue), offset against how much cash is going out. A high revenue doesn’t necessarily mean a healthy cash flow if your expenditures are too high—perhaps you’re spending too much on inventory, salaries or office rent. This makes proper cash flow management one of the most critical components of growing any business—and is where cash flow forecasting comes in.

What is a cash flow forecast?

Conducting a cash flow forecast helps you estimate and project cash flow on a month-to-month basis. This gives you a gauge of how much cash you’ll have to spend on expansion efforts and plan your growth strategy. You can create your cash flow forecast manually using a spreadsheet (there are free templates available online, like this one from Xero), or take advantage of the built-in features on your accounting software to automate forecasts.

Cash flow forecasting is also a way for business owners to evaluate whether their current cash flow management measures are effective. If you’re consistently experiencing lower cash flow than projected, for example, you could ask yourself whether your forecasting assumptions need to be adjusted, or if there are opportunities for you to improve your cash flow, whether through short-term loans or by reviewing operating expenses.

Why is cash flow forecasting important for business expansion and growth?

Having a cash flow forecast can be a powerful way for SMEs to take control of their expansion plans. Because it gives some degree of clarity over how much cash is expected to be available in a month, six months, or a year, it’s easier for business owners to plan and map out their growth strategy. Insights gleaned from the forecast can influence top-level business strategy, such as:

• When should you be saving and when should you be spending?

• When should you be reinvesting your profits?

• When do you foresee a need to seek external financing?

That’s what cash flow forecasting is all about—empowering you with data and insights to make smarter, more proactive financial decisions for your business. Having a well-thought-out forecast also couldn’t hurt your chances of securing a loan, as it shows how and why your growth plan is viable, that you’ve considered key financial risks, and that you’ve mapped out a realistic expansion strategy.

4 tips to improve cash flow forecasting

As with all projections, a cash flow forecast can only provide estimated figures, but here are some pointers for getting them as close to accurate as possible.

1. Identify patterns from past data

Your future forecast is only as good as your current reporting, so be extremely conscientious in monitoring past cash flow and make sure that your accounting books are always up to date. Once your historical data is in place, look for cycles or patterns. Have certain suppliers or vendors showed any differences in payment times recently? Is your revenue quite seasonal, or is it relatively consistent? What are your fixed and variable costs each month? 

2. Create several scenarios

To mitigate uncertainty in the long run, consider multiple scenarios when conducting your forecast. Cash flow is very closely tied to sales, which is one of the most difficult figures to estimate consistently, so try plotting out multiple cash flow scenarios based on projected sales numbers at various tiers. For instance, create different projections for 10% positive sales growth, 0% sales growth, and 10% negative sales growth. Remember to also account for the possible impact of macroeconomic factors, such as changes in taxes, foreign exchange rates, inflation or interest rates.

3. Regularly monitor and adjust your forecasts

Cash flow forecasting is an ongoing process that requires consistent monitoring and adjustment. Doing so can help you to identify opportunities for process optimisation or allow you to take advantage of certain situations where you find yourself in a better cash position than expected. It’s a time-consuming but critical process that will not only tell you how much cash your business is expected to generate, but also if you have enough to fund your expansion plans—and if you don’t, whether you should be seeking additional working capital sooner rather than later.

4. Make the most of your accounting software

While it’s perfectly possible to manually calculate your cash flow forecast using a spreadsheet, investing in a cash management tool that helps automate certain processes and delivers insights at a glance can go a long way to saving you time spent crunching numbers so you can focus more on growth strategy. In that sense, saving on accounting software might be the equivalent of penny-wise but pound-foolish.

It’s normal not to hit your cash flow forecast on the mark, so look at the accuracy of your forecast in terms of degrees—perhaps 5% is an acceptable variance for you overall, with stricter targets in certain categories, especially fixed expenses.

Get proactive about cash flow management

When it comes to cash flow, SMEs tend to have relatively narrow margins of error. Cash flow forecasting can play a big part in helping business owners avoid even short-term cash flow crises, while providing some reliability for planning out future growth. With clear accounting and reporting, business owners are in a stronger position to plan for the long run, rather than make financial decisions on an ad hoc basis.