Guide

How to create a rolling cash flow forecast

At some point in your business journey, you’ve likely heard the phrase “cash is king”. This phrase is said so often because there’s truth to it. If there’s no cash, there’s no business.

Cash flow forecasting is an incredibly important task. Most business owners instinctively know that forecasting is important – but may not understand how to get it right or set one up.

So, how to implement a forecast? You base it on your historical performance. But remember: a perfect forecast is impossible. As the investor Howard Marks put in a memo: “There are no ‘facts’ regarding most future events, just opinions."

With this uncertainty in mind, a rolling cash flow forecast is better suited to most businesses. “Rolling” means the forecast is constantly adjusted. This is perhaps on a quarter-by-quarter or monthly basis, as conditions change and the markets fluctuate.

In this guide, we will show how to set up a rolling cash flow forecast and make it really useful going forward.

Why is forecasting important?

Day to day, business owners make a lot of decisions. Sometimes these decisions will be based on gut instinct and feel. That is fine, and there’s a place for this sort of insight. But other times, a more data-driven approach is more appropriate.

Here’s where forecasting really helps. By using your historic performance to look at the near and medium-term future, you can sharpen your instincts. Most businesses follow patterns, and a forecast offers a clear view of your status.

One key part of a forecast is anticipating your capital needs. In simple terms: money. Ultimately, forecasting is how you’ll understand how much money you’ll need in the future and when.

It’s actually possible to have excess as well as insufficient capital. A forecast will help you spot a shortfall or a good time to invest in your business. It should also help understand why these situations have occurred.

Steps in creating a rolling cash flow forecast

Step one: Set a target

You know your business and you probably have an expected revenue target in mind. Your gut is a good place to start. If you’re not sure, there’s a simple calculation you can do. If you have a target sales volume, multiply it by the average price of your product or service.

So if you want to sell 1000 units and they sell for £100 a go, then your target revenue is £100,000. Don’t worry, this number may not be spot on in the end. You just need a realistic target to aim for.

If your forecast period is 12 months, you now know what’s required on a monthly basis to hit the target. A rolling forecast has no set fiscal year or period. Rolling forecasts are event-based, rather than time-based.

Instead, there’s a continuous roll as you drop periods from the forecast and add new periods to each cycle. For example, if your forecast period lasts for 12 months, as each month ends another month will be added. So you are always forecasting 12 months into the future.

This sort of forecasting requires you to continually revisit your numbers. In other words, it makes you more nimble and strategic.

Step two: Get the right data

There’s data all around your business. This is how you can check your performance on a real-time basis. This varies from business to business.

Relevant data for you could be many things. While new businesses have less data to work with, it could include financial statements or client invoices. Essentially, you’re looking for any information you believe has value to the future of your business.

Step three: Scenario planning

It’s common to create more than one rolling cash flow forecast. Some businesses choose to have up to three.

In this case, each of the three forecasts has a possible outlook:

  • Business as usual scenario
  • A 15-20 per cent drop in revenue scenario
  • A “disaster recovery” scenario where a 50 per cent drop in revenue occurs

Of course, focusing on the negatives is not fun. But a sober view of your business is vital. As the consulting firm McKinsey phrased it, “downturns are impossible to predict and as sure as sunrise”.

Downturns do happen – and forecasting will help you be ready for it. It’s a good idea to lay out your necessary costs. Split these costs into things your business needs and variable costs that can be reduced if needed.

Effective forecasting is the art of eliminating surprises. There are unfortunate events sometimes and they cannot always be helped. But a forecast, based on data, can steer your business through difficult terrain.

Peter Watson, Distract

Peter Watson uses scenario planning to minimise the element of surprise

“We simulated every scenario because I didn’t want anything to come as a surprise. I didn’t want us to sit there and go: ‘Okay, so revenue has gone down by 15 per cent, what on earth do we do now?’ I wanted to make sure we had a full battle plan that was ready to go.”

Peter Watson, managing director of Distract

Step four: Adjust and adapt

Your forecast does not have a life of its own. For a rolling forecast to be effective, it needs a person at the helm. In other words, it’s important to keep an eye on your forecast.

Think of your forecast as a living thing. If there’s a difference between your forecast and the actual numbers, then you need to know why this is. As the economist JK Galbraith explained, there are two types of forecasters: “Those who don’t know and those who don’t know they don’t know."

Variance in your forecast is a red flag. It’s telling you that you don’t know. And as the business owner, it’s up to you to find out. For example, if there’s a difference between actual costs and forecasted costs – why?

Don’t just assume the difference is caused by an unrealistic forecast. That could be the cause. But it could also be a change in market conditions, an unexpected event or unplanned expenses.

Challenge yourself to find out why your forecast is off. If you can deal with the cause, great. If you can’t, then changing your forecast is a good idea.

Improving your forecasting

Depending on how big or complex your company is, a rolling forecast can be a big job. Especially if you’re doing it in a manual way. As people in your business feed in the actual information, you (or your finance team) will update the forecast.

This can become work-intensive. Automation and technology can simplify this and reduce the labour involved in a rolling forecast. Technology is your friend.

Forecasting software is inexpensive and widely available. You even have different software designed for certain sectors. Don’t just use the most widely known software. Do some legwork and find the best fit for your business.

In large part, effective forecasting comes down to three key points:

  • Company culture
  • Systems
  • Data

Company culture

If you’re leading a team, every person needs to buy into your forecast. Especially senior people who provide the data needed to forecast accurately. Forecasting should be part of their jobs, too.

Meet with sales, marketing, production teams and any other relevant team. Explain how an accurate forecast will benefit them: a healthy, stable business that can properly reward high-performing teams and individuals.

As the business grows, you can’t be everywhere. A complete view of the business becomes challenging to maintain. You need able deputies to help you get the full picture.

Systems

For a small business, an Excel spreadsheet could do the job. For others, something more specialist is required. Whichever way you go, remember that your baseline forecast is a living thing.

Analysis and updates are the whole point. So what do you need to put in place to get the insight required? A rolling forecast cannot be done on an informal basis. It will need a process.

Data

Good data really is the secret sauce of any good forecast. Rolling forecasts are vulnerable to bad data since they need a constant influx of numbers. Keep pumping bad numbers in, then the worse it will be distorted.

Good data is whatever the main drivers of your business are. You will instinctively know what these key metrics are for your business. The data needs to be real-time. By including actual data into your forecasts, you can identify issues and priorities faster.

Oddbox

Emilie Vanpoperinghe (right) keeps a close eye on repeat orders at Oddbox

“We’ve always tracked a lot of metrics in terms of acquisition numbers, retention and the delivery percentage. We’ll also look at how many people stay beyond the first box, the fourth box and the eighth box.”

Emilie Vanpoperinghe, co-founder of Oddbox

Forecasting and business growth

In the early days of your business, it’s perfectly OK to keep it simple. Most of what you need to know will be in your head. But as a business grows, it will become more dynamic.

As a result, forecasting will become trickier too. But by following a few simple steps – as outlined above – you can build a solid forecast. A good rolling forecast will help be better prepared for downturns and, perhaps most importantly, for success.

Fortis Engineering Services
Case Study.

Reengineering cash flow helped this engineering firm bridge income periods.