Cash is the lifeblood of any business—and for small and medium-sized enterprises (SMEs), staying on top of cash flow is essential for survival and growth. By forecasting future cash inflows and outflows, you can spot potential shortfalls before they become critical, make smarter financial decisions, and ensure you always have the liquidity to meet your obligations.
Why Cash Flow Forecasting Matters for SMEs
Understanding your cash flow lets you stay in control of your finances and avoid unpleasant surprises. Here’s why it’s critical:
Spot Trouble Early – Forecasting helps you identify periods when cash might be tight.
Support Better Decisions – Use accurate projections to guide hiring, spending, and investment choices.
Secure Financing – Banks and investors often require cash flow forecasts to evaluate your ability to repay or grow.
Plan for Growth – Expansion costs money. Forecasting helps you manage that growth responsibly.
Boost Profitability – By understanding cash patterns, you can fine-tune your payment terms, optimize inventory, and reduce waste.
The Direct Method: Forecasting Actual Cash Movement
The direct method focuses on when money actually enters and leaves your business. It’s great for short-term visibility and day-to-day cash management.
How to Build a Direct Cash Flow Forecast
1. Forecast Customer Receipts
Estimate how much cash you expect to collect from sales, based on historical trends, payment terms, and expected volume. Break this down by product, customer segment, or geography if needed.
2. Forecast Operating Expenses
Project when and how much cash you’ll spend on everyday operations:
Supplier Payments – Based on purchase history and terms.
Payroll – Use your payroll schedule and account for any team changes.
Rent, Utilities, Overhead – Include any fixed monthly costs.
Marketing & Sales Spend – Factor in planned campaigns.
Taxes – Estimate payments based on your tax calendar.
3. Calculate Net Operating Cash Flow
Subtract total outflows from total inflows to get your net cash flow from operating activities.
4. Add Investing Cash Flows
Include expected cash spent or received for long-term assets (like new equipment or property sales).
5. Add Financing Cash Flows
Account for loan proceeds, repayments, investor funding, or dividend payments.
6. Ending Cash Balance
Start with your beginning balance and add the net change from all activities to see where you’ll end up.
The Indirect Method: Start with Net Income
The indirect method begins with your projected net income and adjusts for non-cash items and changes in working capital. It’s often used for longer-term planning.
Steps in the Indirect Method
1. Start with Projected Net Income
Use your forecasted income statement as a starting point.
2. Add Back Non-Cash Items
Include things like depreciation and amortization that reduce income but don’t impact cash.
3. Adjust for Working Capital Changes
Account for cash tied up in receivables, payables, and inventory:
Accounts Receivable – Subtract increases, add decreases.
Inventory – Subtract increases, add decreases.
Accounts Payable – Add increases, subtract decreases.
4. Calculate Operating Cash Flow
Once you adjust for non-cash items and working capital changes, you have your operating cash flow.
5. Add Investing and Financing Flows
These steps mirror the direct method.
6. Ending Cash Balance
Add your net cash flows to your opening cash balance to project your closing cash position.
Choosing the Right Method for Your Business
Direct Method – Offers a more detailed view of your actual cash position and is great for weekly or monthly forecasting. It requires more data input but gives you stronger short-term control.
Indirect Method – Easier to build if you already have income statement projections and accrual-based accounting. It’s often used for quarterly or annual planning.
Many SMEs benefit from using both methods: the direct method for short-term planning and the indirect method for a broader, long-term outlook.
Tailoring Your Forecast to Fit Your SME
1. Start Simple
Begin with a basic forecast and add more detail as you go.
2. Focus on Key Drivers
Prioritize the variables that have the biggest impact—like sales, key expenses, and payment terms.
3. Use Realistic Assumptions
Base your estimates on historical data, market conditions, and known plans. Be ready to revise if things change.
4. Update Frequently
Keep your forecast current by updating it weekly or monthly to reflect actual results and new insights.
5. Run Scenarios
Create best-case, worst-case, and likely scenarios to see how changes in revenue or expenses might affect your cash position.
6. Use the Right Tools
Spreadsheets are a great start, but financial planning software can streamline the process and improve accuracy.
By building a cash flow forecasting process that fits your business, you’ll be better prepared for what’s ahead. Whether it’s covering payroll, investing in growth, or navigating uncertainty, forecasting gives you the insight and confidence to manage your cash—and your business—more effectively.
Mike Torello
CFO,LOREM IPSUM CORPORATION