Cash flow forecast: see your tightest month before it arrives

Leo's bike workshop makes a profit of €37,200 in its first year. In its first month, his bank balance drops from €75,000 to €2,930. Both figures are correct, and the gap between them is the reason a cash flow forecast exists. It follows the money month by month: what arrives, what leaves and what is left. Profitable businesses fail when they cannot pay a bill on the day it is due, and this forecast shows that day coming.

This guide uses the worked example of Chainline Bike Workshop from the guides on business plan financials. The amounts are in euros; the method works in any currency.

Why profit is not cash

The profit and loss forecast records revenue and costs when they belong to a period. The cash flow forecast records money when it moves. They drift apart because customers pay later than they buy, stock is bought before it is sold, assets are paid at once but depreciated over years, VAT passes through your account, loans arrive and are repaid, and you take drawings. Leo's first year shows the size of the gap.

Fictitious Firmfocus example. Amounts exclude VAT except the VAT line itself.

How to build a cash flow forecast

1. 01

   Start with the opening balance

   The money in the account on day one: your own contribution plus the loans that have been paid out.

2. 02

   Enter receipts in the month they arrive

   Including VAT or sales tax. Till sales arrive at once; invoiced work arrives when the customer pays, not when you send the invoice.

3. 03

   Enter payments in the month they leave

   Assets, stock, rent, wages, VAT payments, loan repayments with interest, insurance premiums paid yearly in advance, and your drawings.

4. 04

   Test a setback

   Move a large receipt one month later, or lower sales in your weakest months, and see whether the balance stays above zero.

5. 05

   Update it every month

   Replace forecasts with actual figures and add a month at the end, so you always look a year ahead.

VAT, GST and sales tax in your cash flow forecast

Put VAT in the cash flow forecast, even though it is not in the profit and loss forecast. You collect it on sales and hand it over later; you pay it on purchases and reclaim it later. In between, it sits in your account. At the start, the effect usually runs against you: Leo pays €13,500 of VAT on his assets, stock and start-up costs, and gets it back only through his first quarterly return. When and how often you settle depends on where you are.

Rules change, so check your tax authority's current pages. If you are not registered for VAT or GST, you cannot reclaim tax on purchases and the gross amounts are your cost.

Payment terms: when customers and suppliers pay

In the EU, the Late Payment Directive limits payment periods between businesses to 60 calendar days unless expressly agreed and not grossly unfair, gives public authorities 30 days and in any case no more than 60, and sets statutory interest at the reference rate plus at least eight percentage points, with a fixed €40 compensation per late payment (source: EUR-Lex, February 2011). In the UK, a payment is late 30 days after the invoice or delivery if no date was agreed, agreed terms are usually within 60 days for business transactions, and you can charge 8% plus the Bank of England base rate with a fixed sum of £40, £70 or £100 depending on the debt (source: GOV.UK, August 2016). Elsewhere the rules differ by country and sometimes by sector, so check what applies before you agree terms.

Whatever the law allows, your forecast should use the terms your customers actually keep. Leo's consumers pay at the till. The two hotels he services pay their monthly invoice 30 days later. His parts suppliers give him 30 days as well.

Worked example: twelve months at Chainline Bike Workshop

Leo opens on 1 March. The forecast assumes VAT at 20% with quarterly returns settled the month after each quarter, a busy spring and summer, a quiet winter, stock replenished monthly and paid after 30 days, €8,000 of extra stock in February for the new season, the yearly insurance premium paid in March, €1,250 a month for both loans and €2,500 a month in drawings including a tax reserve.

Fictitious Firmfocus example. Amounts include VAT. June receipts include a VAT refund of €9,194 and June payments the €6,000 supplier credit on the starting stock; VAT payments of €4,266 and €3,114 fall in September and December.

The tightest month

March. Leo pays €89,710 in his opening month: €54,000 for assets including VAT, €18,000 for the first part of his stock, the deposit of €4,500, start-up costs, the full insurance premium and his first month of running costs, loan payments and drawings. Sales bring in €17,640. He ends the month with €2,930, about five days of his normal payments. For comparison, the median small business in a JPMorgan Chase Institute study of 597,000 firms with Chase business accounts held 27 days of cash outflows, and a quarter held fewer than 13 days (source: JPMorgan Chase Institute, September 2016).

The month-end figure also flatters March. If Leo pays every opening invoice before the till fills up, his account goes below zero in the middle of the month.

What Leo does about it

• Shift a payment: the fit-out contractor agrees that the last €6,000 plus VAT is paid 30 days after completion. March then closes at €10,130 and the tightest month becomes April, at €9,572.
• Arrange an overdraft before opening: a standby facility is easier to get while the bank is reviewing the full plan than in a difficult month.
• Ask about VAT timing: he asks his tax office whether a business expecting refunds can file its first return earlier or monthly.
• Look past month twelve: at the end of February €15,984 of supplier invoices and €814 of VAT fall due in March of year two, so he extends the forecast to eighteen months.

Small start or larger start

Pitfalls and warning signs

• Revenue instead of receipts: entering sales in the month you invoice instead of the month you are paid.
• VAT as your own money: spending VAT you have collected and then having nothing when the return is due.
• No setback tested: a forecast that only works if every customer pays on time and every month meets target.
• Only the month-end balance: large payments early in the month and receipts later can push you below zero in between.
• Warning signs in practice: paying suppliers a little later each month, dipping into the tax reserve, an overdraft that never returns to zero, stock growing faster than sales.

The repayments in this forecast come from the financing plan, and the opening payments from the startup costs. For VAT registration and record-keeping see tax and bookkeeping. The overview of business plan financials and Start a business show the wider picture.