How to do a cash flow forecast

business.gov.au describes a cash flow forecast as an estimate of your future sales and costs, and a useful tool for seeing whether you will have enough income to cover your costs. Its glossary defines a forecast more generally as a list of future financial transactions.

A forecast uses the same layout as a cash flow statement, with estimated figures entered for each future period in place of actual ones. business.gov.au says a cash flow statement used this way can help you predict shortages and surpluses and plan ahead so there is money to cover payments.

The two are easy to confuse. business.gov.au puts the difference this way: your budget is a plan for what you want to earn and spend in the financial year, while a forecast looks ahead at what is likely to happen, working from your latest figures and recent trends.

A budget sets goals and decides where money should go. A forecast helps you manage cash flow and change your plans when you need to. business.gov.au suggests writing a budget once a year, with a possible mid-year review, and updating a forecast more often, monthly or quarterly.

• Your current bank balance, which becomes the opening balance for the first month.
• Figures from previous years, if the business has them. business.gov.au's budgeting guide says historical financial data can help you estimate income and costs, and that a new business can use market research or industry benchmarking instead.
• A list of your regular income, such as cash sales and payments from customers you have invoiced.
• A list of your costs and when each is paid: fixed costs such as rent and insurance, and variable costs such as wages, utilities and supplies.
• The due dates for payments you know are coming, such as licence renewals, supplier invoices, rent and loan repayments.
• The payment terms you give customers and get from suppliers, since they decide when money actually moves.

1. Choose your periods, usually months. business.gov.au's cash flow statement template lets you enter estimated figures for each future period.
2. Enter the opening balance: your bank balance at the start of the first month.
3. Estimate cash incoming for each month. business.gov.au suggests thinking about what forms of income the business will have and when, looking at previous years, identifying seasonal trends and allowing for regular sources of income.
4. Put each amount in the month you expect to be paid, not the month you send the invoice. If customers usually pay a month after you invoice them, a sale in March becomes cash in April.
5. Estimate cash outgoing the same way: the costs you need to pay to run the business and when you will pay them, based on previous years, seasonal trends and your major costs.
6. Total the incoming and outgoing figures for each month, then work out the monthly cash balance and the closing balance. Each closing balance becomes the next month's opening balance.
7. Mark every figure as an estimate and note how you arrived at it. business.gov.au says estimated figures should be clearly labelled and explained.

A forecast also lets you try out a decision before you make it. business.gov.au suggests testing adjustments by forecasting with a financial report such as a cash flow statement, and by speaking to an adviser. It also suggests that if your business has known quiet periods, you plan to have enough cash to get through them.

Copy the forecast and change one thing at a time to see how the closing balances move. For example:

• a price rise, or lower sales in a quiet season
• customers paying later than usual
• a large stock order placed ahead of a busy season
• leasing or hiring equipment instead of buying it, which business.gov.au notes spreads out the cost.

A forecast is only as useful as its latest update. At the end of each month, replace that month's estimates with the actual figures, check the closing balance against the bank, and add a new month at the end so the forecast keeps looking the same distance ahead.

business.gov.au recommends comparing estimated and actual income and costs so you can identify shortfalls quickly. Where actual results fall short of the estimates, look for the reason: a customer paying late, a cost that rose, or an estimate that was too hopeful. Then adjust the months ahead to match what you now know.

• Forgetting costs that fall due only now and then, such as licence renewals.
• Estimating income from what you hope to sell rather than from past figures and current orders.
• Building the forecast once and not updating it.
• Mixing actual and estimated figures without marking which is which.