Three-way forecasting – predicting cashflow alongside your balance sheet and P&L

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Understanding your cashflow is vital for any business that’s serious about getting true control over its financial management – and, by doing so, setting the foundations for growth, profitability and the long-term success of the company.

But cashflow doesn’t exist in isolation when it comes to your financial reporting. As any business owner will know, you’ll also be keeping a close eye on your profit and loss (P&L) and your balance sheet, both of which give you a different overview of your business health.

So, how does cashflow fit alongside your P&L and balance sheet? And how can your financial forecasting and planning benefit from combining all three reporting areas together?

Why is cashflow so vital to your business plans?

58% of UK SMEs believe late payments are putting their business at risk of failure according to new research by data specialists Dun & Bradstreet. And it’s this impact of slow or late payment that’s the real reason for understanding your cashflow position in great detail.

Knowing how much cash is coming into, and flowing out of, your business is a critical thing for any business owner to know. It’s a hugely practical consideration of running the company, and a critical element of giving security and stability to your current and future trading.

When you know how much cash you have available, that stops you overspending, overtrading and putting the financial health of the business at risk.

How do I monitor cashflow?

To help understand your cashflow, you need to measure it.

So there’s an ongoing process of monitoring cash inflows (income from sales) and cash outflows (overheads, repayments and expenses etc) – with the aim of keeping the two sides of the cash scales balanced and providing the funds needed to trade.

To do this effectively, there are a number of ways to track that cashflow:

  • Produce a cashflow statement – so you get a full breakdown of your operating, investment and funding cashflows across the business.
  • Run regular cashflow forecasts – giving you an insight into your cash position in a week, a month, or even a whole year ahead – and allowing you to take preventative action to avoid any issues.
  • Use data to enhance your cashflow forecasts – providing the most accurate and real-time data to drive your cashflow forecasts and projections.

By referring to these cashflow reports regularly, you keep your cash under control and give yourself the best possible overview of how your cashflow is performing..

Whilst creating cashflow forecasts can be time-consuming and complex, software like Fluidly can automatically produce cashflow forecasts using Artificial Intelligence and data from your cloud accounting solution.

Understanding your P&L

So a cashflow statement provides the basic summary you need to manage your cash effectively. But how does this tie in with your other key financial reports?

Let’s start by looking at your profit and loss (P&L) report.

Your P&L shows you your revenues, costs and expenses over a given historic period of time. It’s a process, just like cashflow, but what your P&L does is help you understand the revenue coming in and costs/expenses going out, rather than cash coming in and going out.

Because this is essentially a historic report – one that shows what’s happened, rather than a future financial position – it’s a good way to review your performance and to give a reference point for budgeting at the start of the year.

Ultimately, it’s a report that shows you whether the business is making a profit – and it’s important to understand how you could still be profitable (with profit at the end of the period) but still have poor cashflow (i.e. not have the liquid cash you need right now).

What does my balance sheet tell me?

So that’s cash and profit covered. Let’s look at how the balance sheet fits into this picture.

What your balance sheet does is reflect your assets, liabilities and equity at a given point in time. It’s probably the least intuitive of your core financial reports (especially if you’re not a trained accountant), but in essence it’s a snapshot of these financial elements.

To help you understand this concept more clearly, let’s explain a little more about what assets, liabilities and equity actually mean as accounting terms.

  • Assets – your assets are the things you own in the business, whether that’s your cash, your equipment/machinery of your business property etc.
  • Liabilities – your liabilities are the things you owe other people, from the debts you might owe to a bank lender, to the outstanding invoice payments you owe to your suppliers.
  • Equity – the equity in the business comes from the cash invested by the owners, plus any income made (or losses incurred) over time.

These three elements are brought together into the following accounting equation, which lies at the heart of the balance sheet:

‘Assets = Liabilities + Equity’

So, in plain terms, the financial success of your business is directly linked to the income you bring in, the equity your start with and the debts you owe. And your balance sheet is a way to press pause and see this current wealth frozen in time for a moment.

The benefits of a three-way cashflow forecast

What a three-way cashflow forecast does is combine all three key financial reports into one consolidated forecast. It links your P&L, balance sheet and cashflow together so you can forecast your future cash position and financial health.

This three-way approach gives your cashflow numbers greater accounting integrity, because they’re driven by the real-time data in your balance sheet and P&L. That adds real value when it comes to approaching banks and investors for financial support, by giving you granular financial forecasts that explain the future prospects of your business model.

Any assumptions and drivers data are based on genuine historic information – the real-time data from your cloud accounting – making your forecasts more accurate, more robust and giving you the best possible insight into your future financial position.

This all comes together to:

  • Make you and your management more confident about your cash position
  • Make your business more attractive to potential investors and lenders
  • Bring real financial stability to your company, both now and in the future.

Find out how Fluidly helps you get smart with your cashflow forecasts