Cash flow for small business: forecast, stock and credit terms

What is cash flow and why does it matter more than profit?

Cash flow is the money that moves in and out of your bank account, and when it moves. Profit tells you whether the business is worth running; cash tells you whether it can keep running next month.

Most small businesses that fail are not losing money on paper. They run out of cash to pay a supplier, the rent or the wages on a particular day. Profit is a score for the year. Cash is the fuel for this week.

How can a profitable business run out of cash?

Because profit is counted when you sell, and cash arrives when you are paid. Every day between paying for stock and being paid for it is a day your money is out of the bank.

Worked example: a profitable month with an empty bank

A wholesaler wins a large new customer. In the first month:

The accounts show a good month. The bank shows a hole of 90,000. If the business does not have that money, or an agreed overdraft to cover it, it cannot take the order, however profitable it is.

Other things that make cash and profit differ:

• Buying stock costs cash today but only becomes a cost when it sells.
• Loan repayments use cash but are not a cost in your profit.
• Tax bills are paid in lumps, often months after the sales they relate to.
• Equipment is paid for up front but spread across several years in the accounts.
• VAT you collect sits in your bank but is owed to the tax authority.

How do you build a 13-week cash forecast?

List your opening bank balance, then for each of the next 13 weeks write down the cash you expect to come in and go out, and carry the closing balance forward. Update it every week with what actually happened.

Steps:

1. Start with today's bank balance, not your accounting figures.
2. Cash in: till takings by week, plus customer invoices by the date you realistically expect them to be paid, not the due date.
3. Cash out: supplier payments by the date they fall due, wages and payroll taxes, rent, power, loan repayments, VAT and other tax bills, and planned one-offs.
4. Work out the closing balance each week: opening + cash in − cash out.
5. Mark the lowest point. That is the number that matters.
6. Every week, replace the first week's forecast with actual figures, add a new week 13 at the end, and look at what changed.

Worked example: a 13-week forecast

A shop with a trade counter starts with 20,000 in the bank. It pays its main suppliers monthly on statement (weeks 3, 7 and 11), rent every four weeks, and has a tax payment in week 6. Week 7 includes an early order for its busy season.

Sales are steady and the business is profitable. Yet the forecast goes negative in week 7 and stays there, with a low point of −8,300. The causes are visible on the page: the tax payment in week 6 and the early season order in week 7.

Because the owner can see this in week 1, there are six weeks to act. Options include:

• Split the week 7 season order into two deliveries, or ask the supplier for longer terms on it
• Chase overdue trade accounts so more cash lands in weeks 4 to 6
• Hold back reorders on slow lines for a month
• Agree an overdraft or short-term facility now, while the figures still look healthy

Any one of these might be enough. Discovering the problem in week 7 leaves none of them.

How does stock tie up cash?

Every item on your shelves is cash you have spent and not yet got back. The longer stock sits, the more money it locks up, so cutting stock days frees cash straight away.

Stock days = stock at cost ÷ yearly cost of sales × 365

Worked example: freeing cash from stock

A business holds 90,000 of stock at cost. Its cost of sales is 360,000 a year.

• Stock days: 90,000 ÷ 360,000 × 365 = 91 days
• If it cut to 60 days: 360,000 ÷ 365 × 60 = 59,178 of stock
• Cash freed: 90,000 − 59,178 = about 30,800

That cash is freed without selling a single extra item. It comes from buying closer to what actually sells.

Where to look first:

• Slow and dead lines. Anything that has not sold in months. Clear it, even at a lower margin, and do not reorder it.
• Over-ordering on bulk deals. A supplier discount for buying six months' supply is rarely worth it if you are short of cash.
• Reorder points set too high. Base them on real sales and lead times; see our guide to reorder points.
• Stock spread across sites. Moving stock between warehouses can avoid a new order.

Our stock control guide covers this in full.

How do credit terms in and out affect cash?

The terms you give customers and the terms you get from suppliers decide how long your cash is tied up. Collect faster than you pay, and suppliers help fund your stock; pay faster than you collect, and you fund your customers.

The full picture is your cash cycle:

Cash cycle = stock days + customer days − supplier days

• Customer days = money owed by customers ÷ yearly credit sales × 365
• Supplier days = money you owe suppliers ÷ yearly purchases × 365

Worked example: the cash cycle

For 106 days, from paying a supplier to collecting from a customer, the business funds that sale from its own cash. Every day cut from the cycle is money back in the bank.

What the levers are worth here, with purchases of 360,000 a year and credit sales of 480,000 a year:

Credit you give

Give credit on purpose, not by habit. Set a credit limit and payment terms for every account customer, check the ageing every week, and stop supply when an account goes too far over. Our guides on customer credit and getting invoices paid faster go into this in detail.

Credit you take

Suppliers are often more flexible than owners expect, especially for a customer who pays reliably. Ask for longer terms when you renew an agreement or move a large order. Pay on the due date, not early, unless an early-payment discount is worth more than the cash. Never stretch payments without agreement; a supplier who puts you on stop costs more than any interest.

How do day-to-day habits affect cash flow?

Most cash problems start with small, daily leaks rather than one big mistake. A few routines close most of them.

• Cash up every day. Know what you took and where it went. See our end-of-day cash-up guide.
• Bank cash promptly. Takings in a drawer are not working for you and are at risk.
• Invoice on the day of delivery. The payment clock does not start until the invoice is sent.
• Keep VAT and tax money separate. Treat it as never yours; a separate account makes the quarterly bill painless.
• Review the forecast every week, at the same time, even when things look fine.
• Know your lowest point. The closing balance at the bottom of your forecast is the one to plan around, not today's.

What are the early warning signs of a cash problem?

Look for patterns, not single bad days. The signs usually appear weeks before the bank account empties.

• Supplier payments slipping later each month
• Customer days rising, with the same names overdue again
• Stock value climbing faster than sales
• Overdraft used every month rather than occasionally
• Tax payments arriving as a surprise
• Paying one bill by waiting for a particular customer to pay another

If you see two or three of these at once, build or update the 13-week forecast that day.