One of the most common reasons small businesses fail is because they run out of money to cover their costs. For this reason, it is important that business owners draw up forecasts to help predict the flow of cash into and out of their business, as well as their expected sales volumes and likely profits (or losses).
Forecasting can be used to anticipate the future financial position of your business, which helps you plan and manage your resources more effectively. It can also help to identify when to borrow and when to invest and allows you to plan ‘what if’ scenarios, where you can predict the likely impact that a certain decision will have on your business’ finances.
Note: The most effective means of forecasting is to draw up three separate forecasts that feed into one another, including a sales forecast, a profit and loss forecast and a cash flow forecast.
When completing your sales forecast for each month, remember to add up your expected sales based on the amount of work you anticipate and the amount you expect to earn that month, not when you expect to receive the payments from your customers.
Transactions, such as payments from customers will be recorded later in your cash flow forecast.
Cash flow forecasts are used to indicate the likely financial position of your business and to help you identify potential shortfalls and surpluses of cash and don’t need to be accurate to the penny.
That said, it can be easy to overlook certain costs which might skew your cash flow predictions, so be careful to include as many costs as you can remember. Software subscriptions and delivery costs are amongst the most overlooked costs on forecasts and no matter how small they might be, these small costs can add up.
When drawing up your sales forecast and profit and loss forecast your figures should exclude any VAT that you will charge to your customers or reclaim on your costs.
If you can’t reclaim VAT on a particular cost such as business entertainment, this should be added to your profit and loss forecast as part of the business’ day-to-day running costs.
When it comes to drawing up your cash flow forecast, you will need to include VAT on payments and receipts however, because this is the amount that will actually be leaving and entering your bank account. VAT paid to HMRC should also appear under payments.
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In sales and profit and loss forecasts, your sales should be recorded at the time you expect to them to be made and your costs when you expect to incur them.
However, the cash flow forecast is based on money changing hands and should record transactions. when payments are expected to be made to suppliers and received from customers.
Make sure to allow time on your forecasts for customers to pay you and to allow time for you to pay your suppliers.
Sales forecasts and and profit and loss forecasts will not include all cash that comes into and out of your business bank account, however the cash flow forecast must do.
The cash flow forecast includes money paid into the account from sources other than your customers, including borrowed money from family members or the bank.
It also includes money leaving your account for costs other than the day-to-day running costs, which might include taxes or investment in new equipment.
Taking the time to draw up forecasts can be essential to the survival of your business, as it can help to identify periods in the future where your business might require additional cash to meet its liabilities. Forecasting can allow you to arrange your finances in anticipation of such a situation.
By adapting your forecasts you will also be able to predict the likely impact of strategic decisions and unforeseen events on your business, such as renting an additional premises or losing a big client.
Ultimately, the better you can predict, the better you can plan, which could give you that all important edge over your competition.
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