A 3-way financial forecast is more of a three-in-one situation. It’s a single financial model that brings together the three key financial statements:

1. Profit and loss (P&L)
2. Balance sheet
3. Cash flow statement

Here’s a breakdown of each one and the level of insight they provide at different stages of growth, including when it makes sense to start thinking about a 3-way forecast for your UK business.

This article isn’t personal financial or tax advice (you need to speak to us for that).

Early Days: P&L and Cash

Most business owners clearly understand the core aspects of how they generate revenue and the expense components of their business. In an accounting sense, this is all reflected in the profit and loss (P&L) statement.

When your business is just getting started, it’s usually enough to keep a close eye on your P&L and your cash position (i.e. your bank balance). We work with many businesses at this level by operating through a P&L and simple cash forecasts, for as long as possible.

Moving Beyond P&L – Why the Balance Sheet Matters

We have a saying that captures when it’s time to move beyond just your P&L and how much cash you have in the bank:

“If you don’t understand (from your P&L) where your cash is going, the answer is on your balance sheet.”

If you are trying to predict future cash needs, especially as a startup or when juggling cash in growth periods, you’ll quickly realise the other elements that affect cash but are not well reflected in your P&L. These include the following.

Compliance-Based Payments

While you’re probably aware of most of these, ask any UK startup founder about the “gotcha” impact of compliance payments hitting at once. The key ones to plan for:

• VAT – if you’re VAT-registered, you’ll submit quarterly returns to HMRC. The net VAT you’ve collected from customers, less VAT you’ve paid to suppliers, is payable each quarter. Your first few returns can catch you out if you haven’t forecasted for them.
• PAYE and employer NI – income tax and National Insurance withheld from employees, plus employer NI contributions, are payable to HMRC monthly or quarterly. As your team grows, these become a significant and predictable outflow worth building into your model.
• Corporation Tax – for small companies, CT is due 9 months and 1 day after your accounting year end. This lump sum needs to be planned for, particularly in a profitable year.
• Workplace pension contributions – under auto-enrolment, employer contributions (a minimum of 3% of qualifying earnings) are paid monthly. Worth forecasting as your headcount grows.
• R&D tax credits – if you’re eligible and making a claim, this is a positive cash event (a refund from HMRC) that should be factored into your forecast rather than treated as a surprise.

Accounts Receivable and Accounts Payable

Accounts receivable is the money you receive from customers or other people who pay you. Accounts payable is the money you pay suppliers and creditors. Together, accounts receivable and accounts payable drive the working capital needs of your business.

As a simple example, if you send out invoices to customers and there are delays in receiving their payment, you can go broke much quicker than expected, despite being otherwise successful or profitable in theory.

Operationally, you need an active and tight escalation process to collect any money you’re owed. In your financial forecasts, you need to allow for the difference between revenue you have invoiced for and revenue you have received. You might hear this called ‘debtor days’.

When it comes to accounts payable, there can still be delays in paying suppliers even though we have more automatic payment options than ever before – you need to allow for this too.

Loans

If you have any form of interest-bearing loans you need to allow for regular cash payments to cover the loan interest and principal. Loans can include startup loans, shareholder loans, bank loans and even HMRC Time to Pay arrangements.

Other Items

• Revenue recognition – many of our clients receive pre-payments, such as annual contracts (sometimes referred to as ‘bookings’). While this is good from a cash perspective, it is not correct accounting-wise to refer to it as simply revenue. Strictly speaking, you need to recognise one-twelfth of the cash received as revenue over 12 months. This is not just accountant speak – investors and banks will expect to see this in any forecasts.
• Prepayments and deposits – this is kind of the reverse of revenue recognition. It’s where you’re pre-paying suppliers and landlords for subscriptions, insurance, rent and so on.
• Buying capital assets – this involves a monthly depreciation charge in your P&L. This tends to come up when you’re growing fast.

It’s true, we’ve spent more time on this balance sheet section than on the P&L. This is because accounting for the timing of things on the balance sheet in a forecast can quickly become complicated with lots of things to keep track of. As it becomes more complicated, it is better handled in a 3-way forecast.

The Cash Flow Statement

A cash flow statement shows the underlying nature of the money coming into your business and the money going out – your cash inflows and cash outflows.

As the third ‘way’ in a 3-way financial forecast, a cash flow statement is basically a re-statement of your P&L plus movements in your balance sheet, broken into operating, finance and investing activities.

We include it in our 3-way forecasts because it provides an extra level of insight into what the future should hold. However, it’s not usually referred to until you’re much larger. Investors and banks are usually more keen to see that you’ve correctly allowed for and forecast the P&L and balance sheet to provide confidence in your cash forecast.

Getting Help

If you’re at the stage where a 3-way forecast would give you more clarity, we can help. As part of our financial modelling service, we build 3-way forecasts for startups and fast-growing businesses that need financial clarity to confidently pursue their plans.