3 way cash flow forecast: how the three statements link, with an example

Short answer: a 3-way cash flow forecast (or three-way forecast) projects all three financial statements together: the Profit and Loss, the Balance Sheet and the cash flow. They are linked, so every forecast sale, bill, tax payment, loan repayment and dividend lands in the right place in all three, and the forecast Balance Sheet must still balance at the end. That check is the point. A cash-only forecast can quietly leave out the tax you owe or the money customers have not paid yet; a 3-way forecast cannot, because a missing item stops the Balance Sheet balancing. In the worked example below, a plumbing company forecasts $23,000 of profit for the quarter while its bank balance falls by $25,000, and the 3-way forecast shows exactly why.

How the three statements link

Statement	What it forecasts	How it links to the others
Profit and Loss	Sales, costs and profit for the period	Profit after tax adds to retained earnings on the Balance Sheet
Balance Sheet	What the business owns and owes at the end of the period	Opening balance + this period’s movements = closing balance, line by line
Cash flow	Money in and out of the bank, and the closing balance	Its closing cash is the bank line on the Balance Sheet

The movements that connect them are the ones a profit forecast leaves out: customers paying later than they are invoiced (debtors), paying suppliers later than you are billed (creditors), tax provided for now and paid later, loan principal, equipment bought, and dividends or drawings. A plain cash flow forecast can include all of these too, but nothing forces you to; in a 3-way forecast they are how the statements tie together.

A worked example: a plumbing company in Geelong

These figures are made up. Dan’s plumbing company is a small Pty Ltd that forecasts the quarter from January to March 2027. Figures are in Australian dollars and, to keep the example short, leave out GST (in a real forecast the GST collected and paid builds up as a liability on the Balance Sheet and is paid with the BAS).

Start: the Balance Sheet at 31 December 2026, straight from Xero.

31 December 2026	$
Bank	42,000
Debtors (customers who owe the company)	65,000
Van, after depreciation	30,000
less creditors (bills not yet paid)	(18,000)
less equipment loan	(40,000)
less company tax owed for last year	(12,000)
Net assets = equity	67,000

Brackets are minus figures.

Step 1: the forecast Profit and Loss for the quarter.

January to March 2027	$
Sales	210,000
less materials and subcontractors	(84,000)
less wages, including the directors and super	(78,000)
less overheads (rent, vehicles, insurance, phones)	(21,000)
less depreciation on the van	(3,000)
less interest on the loan	(1,000)
Net profit before tax	23,000
less company tax at 25%	(5,750)
Profit after tax	17,250

Step 2: the assumptions that are not in the Profit and Loss. Work is busy, so Dan expects customers to owe $80,000 at the end of March (they owe $65,000 now). Supplier bills owed rise from $18,000 to $20,000. Last year’s $12,000 of company tax is due in the quarter. The loan repays $6,000 of principal, and the directors plan a $20,000 dividend.

Step 3: the cash flow, worked out from the first two steps.

January to March 2027	$
Received from customers: 65,000 + 210,000 − 80,000	195,000
Paid to suppliers: 18,000 + 84,000 + 21,000 − 20,000	(103,000)
Wages	(78,000)
Interest	(1,000)
Last year’s company tax	(12,000)
Cash from trading	1,000
Loan principal	(6,000)
Dividend	(20,000)
Change in the bank	(25,000)
Bank at 31 March: 42,000 − 25,000	17,000

Step 4: the closing Balance Sheet, and the check.

31 March 2027	$	How it moved
Bank	17,000	from the cash flow
Debtors	80,000	the assumption in step 2
Van	27,000	30,000 less 3,000 of depreciation
less creditors	(20,000)	the assumption in step 2
less equipment loan	(34,000)	40,000 less 6,000 of principal
less company tax owed	(5,750)	12,000 paid, 5,750 added for this quarter
Net assets	64,250
Equity	64,250	67,000 + 17,250 profit − 20,000 dividend

Net assets equal equity, so the forecast balances: nothing was missed and nothing was counted twice. If the two figures differ, some movement went into one statement and not another, and the gap is usually the size of the missing item.

What the forecast tells Dan

The Profit and Loss says the quarter makes $23,000. The bank says the company ends it with $17,000, down $25,000. The 3-way forecast explains every dollar of the gap: 23,000 of profit + 3,000 of depreciation (a cost that is not a payment) − 15,000 more owed by customers + 2,000 more owed to suppliers − 12,000 of last year’s tax = 1,000 of cash from trading, and then the loan and the dividend take 26,000 more. The usual causes are covered in profit in Xero but no cash in the bank.

A what-if: a second van in March

Dan wants a second van for $45,000 in March. On the Profit and Loss it barely shows: depreciated over five years, it costs $750 a month. The other two statements tell the real story.

Option	Bank at 31 March	What else changes on the Balance Sheet
Pay cash, keep the dividend	17,000 − 45,000 = $28,000 overdrawn	Vans +45,000
Finance $36,000, pay a $9,000 deposit, skip the dividend	17,000 + 20,000 − 9,000 = $28,000	Vans +45,000, loan +36,000, equity 20,000 higher
Pay cash, skip the dividend, customers pay at today’s pace (debtors stay at $65,000)	17,000 + 20,000 + 15,000 − 45,000 = $7,000	Vans +45,000, debtors 15,000 lower, equity 20,000 higher

Each option still balances, because each one is a matched pair of entries: cash out and a van in, or a van in and a loan in. A cash-only forecast would show the bank figures but not the $36,000 still owed at the end of the second option; a profit forecast alone would show none of it. The loan repayments then go into next quarter’s forecast, and cash flow cover shows how a lender will judge whether the business can afford them. Whether the van is worth buying at all is a separate question: the extra work it brings in, less its running costs and price, which the incremental cash flow guide works through.

How to build a 3-way forecast from Xero

Xero’s own budgets are Profit and Loss budgets, and its short-term cash flow looks only days ahead, so a 3-way forecast is built either in a spreadsheet or in a forecasting add-on that connects to Xero (Fathom is one; see Xero reporting tools compared). In a spreadsheet:

1. Opening Balance Sheet. Run Accounting › Reports › Balance Sheet at the last month end you have reconciled. That is your starting point. (How to read it.)
2. Profit and Loss forecast. Start from Profit and Loss by month for the last 12 months and change only what you know will change. The profit and loss forecast guide walks through it.
3. Timing assumptions. From Aged Receivables and Aged Payables, work out how long customers and suppliers take to pay (the debtor days calculator does the customer side). Add the dates of GST, PAYG and company tax payments, super, loan repayments, planned equipment and dividends or drawings.
4. Cash flow. For each month, cash received = opening debtors + sales − closing debtors; do the same for suppliers. Add the payments from step 3.
5. Closing Balance Sheet and the check. Roll each Balance Sheet line forward and confirm assets less liabilities equals opening equity + profit after tax − dividends or drawings. Retained earnings is where profit lands (what it means).

Each month’s closing Balance Sheet is the next month’s opening one. If you only need the bank balance, the cash flow part on its own, driven by the same timing assumptions, is a cash flow model, with a worked six-month example and four what-ifs. Menu names move between Xero releases and regions, so search Xero Central for the report name if your screen differs.

Common mistakes

• Forecasting cash from sales. Customers pay later than they are invoiced. When sales grow, debtors grow too, and that money is not in the bank yet.
• Leaving out tax. Company tax, PAYG instalments and GST are paid on their own dates, often in a lump. They sit on the Balance Sheet until paid.
• Forgetting loan principal and drawings. Neither is on the Profit and Loss. Both come out of the bank.
• Ignoring a Balance Sheet that does not balance. The difference is a missing or doubled entry. Find it before you trust the cash line.
• Starting from an unreconciled month. If the bank in Xero does not match the real bank, the forecast starts wrong. Reconcile first (why the balance can differ).
• Building it once. Replace forecast months with actual figures as they close, and roll the forecast forward.

Common questions

What is a 3 way cash flow forecast? It is a forecast of the Profit and Loss, Balance Sheet and cash flow together, linked so that each forecast transaction appears in all three. Because the forecast Balance Sheet has to balance, it catches missing items such as tax, loan repayments and money customers have not paid yet.

What is the difference between a cash flow forecast and a 3-way forecast? A cash flow forecast projects only money in and out of the bank. A 3-way forecast also projects profit and the Balance Sheet, and links all three, so you see what the business will earn, what it will owe and what it will hold at each month end, not only the cash.

Do I need a 3-way forecast? Many small businesses manage well with a 13-week cash flow forecast for the coming quarter. A 3-way forecast is worth building before a bank loan or finance application, a large purchase, a new hire on thin cash, or a sale of the business, because lenders and buyers ask for projected Balance Sheets as well as profit.

Can Xero do a 3-way forecast? Not on its own. Xero’s budgets cover the Profit and Loss, and short-term cash flow covers the next few days or weeks. Use a spreadsheet built from Xero’s reports, or a forecasting add-on that connects to Xero.

Why does the Balance Sheet have to balance? Every transaction has two sides: a sale adds to sales and to debtors, a loan repayment takes from the bank and from the loan. If each forecast movement is entered both ways, assets less liabilities always equals equity. When they differ, an entry is missing one side.

How far ahead should a 3-way forecast go? Usually 12 months by month, sometimes up to three years for a loan or investment. The first few months matter most, because they are the most accurate. Update it every month with actual figures.

The actual figures, every Monday

ReportPilot reads your Xero figures and sends a short plain-English email every Monday. It covers sales and profit against last month and the same month last year, the cash in the bank against the end of last month, money owed to you that is past due and by whom, and bills due in the next two weeks against your cash. It does not build forecasts, but it shows each week whether the actuals are tracking your plan. It asks Xero for read-only access, and there is a 14-day free trial with no card.