Cash flow forecast: how to build one and what it changes
Cash flow forecast: how to build one and what it changes
A business can close the month with a profit and, four weeks later, have nothing to pay payroll with. It is not an accounting error or a bad streak: it is the distance between recognising a sale and receiving the money. A cash flow forecast measures that distance before it turns into a liquidity problem, and it helps you decide how much inventory to buy and what payment terms to give each customer. Here is how to build one in a small business that carries inventory, with an example where cash goes negative in week 3 while the margin stays positive.
Why a profitable business runs out of money
The cycle repeats every month: goods arrive, the supplier gets paid, the sale happens and the invoice sits unpaid for 30 or 60 days. In the income statement that sale is already revenue. In the bank account the money is not there yet. If payroll, rent or the loan instalment fall inside that gap, the business enters a zone where profit helps no one.
The gap does not close by selling faster; selling more on credit makes it bigger. What makes it visible is a weekly forecast of collections and payments ordered by date: not an expense budget, but the list of what will come in and go out, with the day it happens.
If the bank asked you tomorrow how you will pay payroll for the next six weeks, would you have the numbers or a feeling?
Profit, cash and accrual: the difference you have to understand
Accounting records events when they happen, not when they are paid. That is accrual: the sale is booked the day it is invoiced, even if the customer pays a month later; the expense is booked when the service is received, even if it is paid in the next cycle.
The rule is right for measuring results and for complying with the DIAN, but it measures profit, not liquidity: a business can close the year with a profit and run out of cash in March.
Cash moves on a different clock: the day the money enters or leaves. These are the differences most often forgotten:
| Event | Hits profit | Moves cash |
|---|---|---|
| Sale on 30-day credit | The invoice date | The collection date |
| Inventory purchase | When the goods are sold | The day the supplier is paid |
| Monthly payroll | In the month worked | On payday and on contribution dates |
| Depreciation of equipment | Every month, as an expense | Never: no money leaves |
| Loan disbursement | It is not revenue | The day it lands in the account |
| VAT on a sale | It is not your expense | On the tax calendar date |
| Customer deposit | Not revenue yet | The day it is received |
Every one of those lines is correct on its own ground. The mistake is using the income statement to decide whether there is money to pay on Friday.
The two methods and which one helps you decide
There are two ways to build the forecast and they do not compete: they answer different questions.
Direct method. You forecast the actual collections and payments of the period: every invoice you expect to collect, every obligation you expect to pay. The result is a timeline of inflows and outflows with a closing balance for each week.
Indirect method. You start from profit and adjust it: add back depreciation, an expense with no cash outflow; subtract the increase in receivables and inventory, which are sales not collected and purchases not sold; and add the increase in payables, which are purchases not paid.
For a small business with inventory, the direct method is usually more useful for deciding, because it shows the exact date of the squeeze and lets you act on it: call a customer, postpone an order, negotiate terms. The indirect method is for reconciling with the accounting records and for explaining to a bank why profit did not turn into cash.
If you can only pick one, run the direct method weekly and the indirect method once a month as a control: the direct method errs on the details, the indirect method errs on timing.
Working capital: the money the operation ties up
Working capital is inventory plus receivables minus payables: what sits in the warehouse, plus what customers owe you, minus what you owe your suppliers. It is real money, already invested, that is not available for anything else.
With the figures in this article's example: inventory 54,000,000, receivables 60,000,000, payables 36,000,000. Working capital: 78,000,000.
Here is the growth trap. If sales rise 20 %, receivables, inventory and payables rise in the same proportion, and working capital goes from 78 to 93.6 million: 15.6 million extra just to hold the new size. Growing without cash is the most common way to go broke with good numbers.
Before approving a sales increase, ask how much additional working capital it requires and where that will come from. If the answer is "from the same cash flow", the hole will show up three months later.
The cash conversion cycle in three numbers
Three day counts govern the cash of any business with inventory. Days inventory outstanding (DIO): how long goods take to sell. Days sales outstanding (DSO): how long credit sales take to be collected. Days payables outstanding (DPO): how long the company takes to pay what it bought.
The cash conversion cycle is DIO plus DSO minus DPO. With the example: 45 days of inventory, 30 of receivables and 30 of payables give 45 days. The company takes 45 days to recover the money it put into the operation.
The sign matters. If positive, the company funds its operation with its own resources or with debt, and that costs money. If negative, suppliers are the ones funding it: you collect before you pay.
With a daily cost of sales of 1,200,000, a 45-day cycle requires 54,000,000 of permanent funding. The gap with the 78 million of working capital is the margin that already travels inside receivables: the cycle says how many days, working capital says how many pesos.
Every day cut from inventory or receivables frees 1,200,000, and every day added to supplier terms frees another 1,200,000: an agreement for 15 extra days frees 18,000,000 without borrowing a peso.
How to forecast collections that will actually arrive
The temptation is to take the month's sales and assume they are collected in full. It almost never happens. The forecast is built invoice by invoice, with each customer's likely payment date, following three rules.
- Forecast the invoice, not the promise. A customer who says "next week" without a date does not land next week: place it according to that customer's actual payment history.
- Every customer has its own terms. A large customer may pay at 60 or 90 days even when the invoice says 30; forecasting everyone at 30 is the mistake that makes cash look better than it is.
- Overdue receivables are separated. Anything past 90 days does not get collected just because you forecast it again.
Two adjustments improve accuracy: an early-payment discount, which pulls receivables forward with a known cost, and concentration control. If three customers account for 70 % of collections, the forecast is not an estimate: it is a bet that those three will pay.
An optimistic collection is a decision disguised as a number. If next month's cash depends on a customer who is always late, the problem is not the forecast: it is the credit policy.
How to forecast payments without forgetting the non-suppliers
Supplier payments are the easy ones to list and the ones that surprise you least, because they have an invoice and a due date. The risk sits in everything else: payroll and its contributions, rent, utilities, insurance, maintenance, loan instalments and taxes.
- Sort by due date, not invoice date. An invoice received on the 3rd with 60-day terms is paid two months later, not this month.
- Payroll is not just salary: there are contributions, provisions and payments that fall in specific months of the year. If there are employees, those months look different and the forecast has to reflect it.
- Taxes run on their own calendar and do not forgive. VAT, withholding and income tax are paid on fixed dates, whether or not the customer has paid you: the company ends up paying VAT on a sale it has not collected.
Splitting the forecast into two blocks helps: certain payments and conditional payments. The first happen no matter what; the second depend on a decision, such as an inventory purchase. Deciding on the conditional ones is far easier when they are isolated and quantified.
A 13-week example with negative cash in week 3
A distributor sells 60,000,000 a month: 40 % cash and 60 % on 30-day credit; it buys 36,000,000 on 30-day terms and spends 15,000,000 on payroll and operations. It starts the quarter with 8,000,000 in the bank; each month is split into four equal weeks.
Week 3 coincides with the payment of a seasonal inventory purchase of 22,000,000, made to serve a peak that will be collected between weeks 6 and 9. The first four weeks look like this:
| Item | Week 1 | Week 2 | Week 3 | Week 4 |
|---|---|---|---|---|
| Opening balance | 8,000,000 | 10,250,000 | 12,500,000 | -7,250,000 |
| Cash collections (40 %) | 6,000,000 | 6,000,000 | 6,000,000 | 6,000,000 |
| Receivable collections (60 % at 30 days) | 9,000,000 | 9,000,000 | 9,000,000 | 9,000,000 |
| Total collections | 15,000,000 | 15,000,000 | 15,000,000 | 15,000,000 |
| Supplier payments | 9,000,000 | 9,000,000 | 9,000,000 | 9,000,000 |
| Payroll and expenses | 3,750,000 | 3,750,000 | 3,750,000 | 3,750,000 |
| Seasonal purchase | - | - | 22,000,000 | - |
| Total payments | 12,750,000 | 12,750,000 | 34,750,000 | 12,750,000 |
| Net flow | 2,250,000 | 2,250,000 | -19,750,000 | 2,250,000 |
| Closing balance | 10,250,000 | 12,500,000 | -7,250,000 | -5,000,000 |
The margin is positive: each week brings in 15 million and pays out 12.75, which is 2.25 million of profit. Even so, cash reaches -7,250,000 in week 3 and stays negative in week 4.
The explanation is in the nature of the payment. The 22 million is not an expense of the period: it is inventory, an asset sitting in the warehouse. That is why the income statement still shows a profit and the bank statement still shows an overdraft: the sale that justifies the purchase has not happened yet.
With all 13 weeks projected the picture is complete: cash recovers around week 7, when the peak's collections arrive, but on the way there are four weeks in the red. Whoever only reviews the full month discovers the hole the day the bank rejects a payment.
The three levers to close a cash gap
Once the gap is identified, three levers remain and one financing decision. Each has a measurable effect and a cost, and almost none solves it alone.
| Lever | What you do | Effect in week 3 | Cost or risk |
|---|---|---|---|
| Collect earlier | 5 % discount to bring 15,000,000 of receivables forward | Balance rises to about 7,000,000 | 750,000 of margin and customers who get used to the discount |
| Buy less | Cut the seasonal purchase from 22 to 14 million | Balance ends at 750,000 | Risk of running out of stock during the peak |
| Pay later | Negotiate 15 extra days with the supplier | Rises to 14,750,000, but week 5 falls to -2,750,000 | Friction with the supplier and possible loss of a discount |
Collecting earlier is the fastest and the most expensive in margin: with 5 % to bring 15,000,000 forward, 14,250,000 comes in, week 3 rises to about 7,000,000 and the cost is 750,000. The real risk is that the customer learns to wait for the discount before paying. Buying less leaves week 3 at 750,000 with the margin intact, but exposes you to a stockout during the peak: a sale you do not make does not come back. Paying later pushes the payment to week 5, where cash falls to -2,750,000: it buys time, it does not close the gap.
If no combination is enough, the fourth option is financing: a credit line sized to the hole, not larger. Borrowing 10 million against a 7.25 million shortfall is reasonable; borrowing 30 without calculating the hole is creating next month's problem.
Scenarios: base, conservative and stress
A single forecast is a bet. Three scenarios show the range of what is possible and let you decide with the worst one, not the most comfortable.
- Base: what was agreed happens and customers pay within their historical terms.
- Conservative: collections slip 15 days and sales fall 10 %. This is the scenario to decide with.
- Stress: the largest customer is 45 days late and sales drop 20 %. Here you do not decide: you check whether the business survives and what would have to be cut.
The rule is uncomfortable but clear: you do not average scenarios. The average of a disaster and a good month is not a plan, it is a statistical illusion. You decide with the scenario the business can withstand, and the optimistic one only tells you how much you would make if everything goes well.
Two variables move almost everything: collection days and inventory levels. Test what happens if DSO goes from 30 to 45 days and inventory grows 15 %: in most small businesses those two changes separate a calm year from an anguished one.
How to read the flow every month without fooling yourself
A forecast that is not updated is decoration. The value is in the weekly comparison of projected against actual, line by line: the closing balance tells you whether there was a problem, the deviation per line tells you why. These are the costliest mistakes:
| Mistake | How it looks | What it causes |
|---|---|---|
| Forecasting every customer at 30 days | Cash looks comfortable and is not | Overdraft and over-committed purchases |
| Forgetting taxes and loan instalments | The month looks fine until the due date | Default on the tax calendar and with the bank |
| Counting open deals as collections | Round numbers that never materialise | Purchases decided on money that does not exist |
| Not separating overdue receivables | You forecast as if everything will be paid | Funding the operation with ever more expensive debt |
| Updating only in a crisis | The model is three months behind | Late purchases and emergency discounts |
The weekly review takes under half an hour if the model is well built: update actual collections, actual payments and bank balances, then run the forecast forward again. What changes is not the past, it is the date the business runs out of cash.
An honest close before you decide
A cash flow forecast does not replace your accountant or the income statement. It is a decision tool and it depends on the quality of its assumptions: if the collection dates are optimistic, the output will be a fiction neatly arranged in columns.
Nor does it apply equally to everyone. A service business that collects cash and carries no inventory has a short cycle and its forecast is almost trivial; an importer with goods in transit and 90-day terms needs a more detailed model. And if the business is already in a liquidity crisis, the forecast is for prioritising payments, not avoiding them.
What does hold for almost any small business with inventory: the conversation about purchases, terms and customer credit changes when a 13-week table is on the table. You stop arguing opinions and start arguing dates. Start simple, with one sheet of weekly collections, payments and balance, three scenarios and a Monday review. If invoice volume makes it impossible to keep by hand, inventory and invoicing software that pulls in actual receivables and purchases, such as Kardex Tauro, cuts the update to a few minutes and leaves the time for what matters: deciding.
