Financial management is one of the most important aspects of any successful business. Cash flow forecasting is one of the most strategic and straightforward financial tools at an entrepreneur’s disposal. Regardless of whether you are the founder of a startup, the owner of an SME, or a corporate financial executive, accurate cash flow forecasting can assist you in making optimal decisions, steering clear of liquidity crises, and confidently capitalising on growth opportunities.
In this blog we are going to take a look at what cash flow forecasting is, why it is important and (probably most importantly) how do you actually create a cash flow forecast for you and your business.
What is cash flow forecasting?
Forecasting cash flow is the analysis process that estimates how much cash the business will move in or out in a period. This helps business owners and finance managers to know the money the company will have in hand from time to time. A cash flow forecast differs from income statements or balance sheets in that it takes a look to the future, allowing one to plan ahead for inflows and outflows in the month-to-month or year-to-year future.
The primary goal is to make sure the company always has sufficient cash to pay for its operations including payroll, rent, purchases of inventory, and loan payments. At the same time, good cash flow planning is essential to ensure that your business, even if it is making money, does not encounter short-term liquidity problems that can lead to forced debt or missed opportunities.
Read More: What is Cash Flow Forecasting? How to Build a Cash Flow Forecast
Importance of Cash Flow Forecasting
Cash is king in any business. It is good to posseses a good product or a large customer base, however, operations come to a halt in the absence of adequate liquidity. And this is where forecasting business cash comes in handy.
Hence, some of the reasons indicating the need for businesses to fundamentally consider cash flow forecasting are as follows —
Avoid Liquidity Crises
Good cash flow planning gives you insight into when you expect any cash shortages and enables action in plenty of time: taking out a short-term loan or postponing non-urgent purchases.
Improve Decision-Making
With clarity on projected cash inflows and outflows, it becomes easier to make capital investment, hiring, and expansion decisions.
Build Trust with Stakeholders
Businesses that prove they plan for strong finances are attractive to lenders, investors, and partners. A credible cash flow forecast will make your company believe you and help you getting funded.
Streamline Operational Efficiency
In that case, timings and location of cash availability will help you manage the inventory in a more streamlined way, which will ultimately help you rock in supplier negotiations and timely payments.
What to Include in a Cash Flow Forecast
It is important to know what a cash flow forecast consists of before we start learning how to build a cash flow forecast. Cash flow forecasts usually contain the following:
Opening Balance
Cash balance at first time period of projection
Cash Inflows
Any anticipated receipts of cash, such as payments from customers, sale of property, stock, grants, tax refunds or other financing.
Cash Outflows
All anticipated payments like salary, rent, utilities, consented, interest and tax.
Closing Balance
Computation by inflows and outflows plus opening balance. This means that you know how much cash is left at the end of this period.
A well-built cash flow forecast will provide these numbers on a weekly/monthly/quarterly basis, depending on the need of the business.
Steps to Creating a Cash Flow Forecast
Forecasting accurately does not have to be rocket science. To create a strong cash flow forecast that suits your business, follow these steps:
Step 1: Choosing a Forecasting Period
Determine if you require a short-term or long-term forecast. The short-term cash flow covering a period between 4 to 13 weeks is usually good for covering your day-to-day liquidity, and the long-term cash flow – covering a period between 6 to 12 months is good for strategic planning.
Step 2: List Down All Your Source of Income
First, list out every potential income stream during the timeframe. While for most businesses, this includes customer payments, it also includes one-off receipts, such as tax rebates or asset sales so do not skip these.
So just because you send an invoice to a customer today, does not mean you will receive money today, and be realistic on your timelines.
Step 3: Outgoing Payments Estimate
After that, enumerate all the outgoing cash flows you expect. Consider both fixed costs (rent, salary etc) and variable costs (raw material or utility bills). I suggest that you should not forget for rare but large expenses, such as signing tax to be paid or signing for the insurance premium, etc…
Step 4: Enter Opening Cash Balance
Beginning Cash: The cash your company has available to start the forecast period. It is the beginning of the computation.
Stage 5: Net Money Movement
To calculate the net cash flow during each period, subtract total outflows from total inflows. Take this amount and add to it to your opening balance in order to receive the closing cash balance.
For example:
Opening Balance = $50,000
Cash Inflows = $30,000
Cash Outflows = $40,000
Net Cash Flow = -$10,000
Closing Balance = $40,000
Step 6: Review and Adjust
Business cash forecasting is an ongoing and never-ending exercise. The markets can shift, clients can take ages to pay you, and the costs can suddenly rock-bound higher. Make your forecast a living document that you revisit and revise figures as new data comes into play.
Tips on Cash Flow Planning
A cash flow forecast is only the starting point of what you need to do. Effective cash flow forecasting is key to good cash management, here are some handy tips to help you on your way;
Use Accounting Software
Many of the processes that come with accounting can now be automated with the east of modern accounting tools. By linking into your bank and invoicing system, they are more able to give you clear and instant cash flow planning.
Keep It Dynamic
Your cash flow forecast, much like every part of your business, should be a dynamic document, not a static one. Weekly or monthly reviews and update numbers as actuals become known.
Scenario Planning
Avoid single point forecastss. Execute several scenarios best case, worst case, and expected case. It will mentally prepare you for the unexpected, and when it does become a reality, teach you how to take action with confidence.
Monitor Receivables Closely
A cash flow forecast that includes late payments is shot to hell, even in the best of times, right? Keep track of accounts receivable and contact slow-paying clients.
Align with Business Goals
Let your cash flow forecasting informed your bigger financial and operational picture – launching a new product, opening a new office or accelerating hiring, etc.
Common errors in cash flow forecasting
Albeit important, a lot of businesses get cashflow forecasting very wrong. Let’s look at some common mistakes to watch out for:
- Income projections: Do not highball on your income estimates since a shortage of cash may follow.
- Neglecting seasonal variations: Most industries experience fluctuation in demand; failing to factor in seasonality can render forecasts misleading.
- Ignoring Taxes: A hefty portion of your dry powder can be eaten up by your quarterly or annual tax bill.
- Not accounting for little expenses: Small recurring bills can mount, and throw off your closing balance.
- Not updating forecasts: Outdated information results in poor predictions.
Steering clear of these mistakes is how you can make sure your efforts around business cash forecasting do not lose their utility and trustworthiness.
Final Thoughts
Cash flow forecasting is one of the basic fundamentals of managing an enterprise and no business can afford to ignore this. From navigating that startup somewhere in the middle of a raging ocean to finding the tight rope to balance on with a well-established business that is simply not scaling as quickly as you would like, a well-constructed cash flow model can be your guiding star.
Knowing how to create a cash flow forecast allows you to plan ahead, react promptly to risks posed and take advantage of opportunities with numbers in hand. After all, a plan with updates, smart tools, you will surely put your business in a favorable position to ensure you have liquidity and expansion prepared, no matter the circumstances.
So take charge of your finances — plan cash flow patiently, practice sound cash flow and put your business on the path to long term financial success.
