written by
Steve Kincanon
published Dec 30, 2023
Cash flow forecasting is like a veteran chess player analyzing their opponent's strategy and calculating their moves. Just as they anticipate and plan several steps ahead, a business must meticulously estimate its cash inflow and outflow while considering various economic factors and potential challenges to stay afloat in the business world.
One must also emphasize the importance of cash flow management, as statistics reveal that 82% of small businesses fail due to cash flow problems. That is why most large companies have finance departments dedicated to handling this to keep the company afloat.
With this article, you'll learn more about cash flow forecasting and its benefits, pitfalls, and mistakes to avoid when forecasting cash flow. Let's get started!
What Is Cash Flow Forecasting, and Why Is it Important for Businesses of All Sizes?
With a cash flow forecast, you can estimate the amount of money that comes into a company's account over a defined period. The money that comes in is called cash inflow, while the amount that leaves the account is cash outflow.
Cash may flow in due to selling an asset or receiving a debt payment and will flow out whenever the company pays its workers, repays loans, or buys new assets. If the total inflow over a measurable period is more significant than the outflow, the company is faring well.
Do not confuse cash flow with an income statement, as they differ. The former shows the movement of funds in and out, while the latter shows a company's total revenue and expenses (including cash and non-cash) over time.
Cash flow forecasting provides a basis for companies to recognize potential obstacles by providing a comprehensive view of anticipated cash inflow and outflow. Therefore, by comparing projected data with their real-time performance, companies can detect discrepancies and proactively address issues that may arise due to a lack of funds, such as delayed payments.
As a result, many companies are now managing cash flow by anticipating future price fluctuations. With these predictions, they can make well-informed financial decisions like investments, expenditures, and savings.
In addition, the insights from cash flow forecasting can guide businesses to chart their course toward attaining their goals. It lets decision-makers know whether investing at a given time is right. Overall, cash flow forecasting aids businesses in making financial decisions that will keep them afloat and facilitate expansion.
Steps to Properly Forecast Cash Flow
Forecasting cash flow is important for planning business finances and is technically the work of an accountant. Following the steps below, you will learn how to forecast cash flow and create a simple forecast for your business.
1. Decide the Reporting Period
Based on your goal and purpose of forecasting, you can do a short-term, medium-term, or long-term forecast. Short-term forecasting involves estimating cash flow over a short period, usually one month or less. It is suitable for planning related to immediate liquidity needs, such as day-to-day operational expenses.
Medium-term forecasting provides an estimate of cash flow two to six months ahead. It provides insight that helps minimize debts and risks. It is also helpful in identifying and avoiding potential dangers.
Long-term forecasting projects six to twelve months ahead. It is helpful in evaluating growth strategy and investment initiatives. Long-term forecasts are less accurate than shorter ones; the shorter, the better.
2. Forecast Income and Cash Inflow
To forecast your business income, you need to look at the previous year's data to identify trends. Trends can serve as a guide in adjusting sales forecasts, especially for medium- and long-term forecasting. After identifying trends, list all your business's cash, sales, and non-sales income for each week or month of the forecast period.
3. Estimate Expenses and Cash Outflow
Once you have determined your incoming cash, the next thing to do is to estimate your expenses. Create a list of all your anticipated expenditures, such as rent, salaries, raw materials, assets, etc.
4. Work Out Running Cash Flow
To work out your running cash flow, subtract the net cash outflow from your net cash inflow within a week or month of your forecasting period. The value you obtain may be negative or positive depending on whether you are sustaining a profit or loss.
If your value is negative, solve problems leading to losses quickly. Conversely, positive values suggest available funds for expansion or investment. You can keep a cumulative record, either weekly or monthly, to visualize your cash flow projections progressively.
Benefits of Cash Flow Forecasting
In addition to accounting for the money that comes in and goes out of your business, cash flow forecasting provides a handful of other advantages, such as those listed below.
Making Better Decisions: Having an idea of your future cash flow will enable you to make decisions to track your expenditures and increase cash reserves. The reserves will be useful for corporate turnaround and covering any unforeseen expenses.
Planning for Business Growth: A cash flow forecast can help you gauge the potential impact of expansion on your financial position. For example, if you decide to set up a branch in a new city, your cash flow forecast will show you the feasibility of this expansion. With a proper forecast, you will easily identify potential financial constraints from the expansion.
Track Your Spending: Cash flow forecasting provides a framework for monitoring expenses. It can help you mind your spending pattern and avoid excessive spending. This way, you can cut costs and draw a budget to ensure financial stability and proper resource allocation.
Project Appraisal: With a cash flow forecast, you can simulate various business scenarios and estimate their impacts and potential consequences. For example, a detailed cash flow forecast can reveal the impact of changing your advertisement strategy or employing new staff in your business. With this analysis, you can keep your business financially stable during changes.
Common Pitfalls and Mistakes to Avoid When Forecasting Cash Flow
While cash flow forecasting has a lot of promising advantages, you need to pay attention to some factors that can rob you of these advantages and may even lead to a devastating end when neglected. So, what factors should you consider when forecasting your cash flow?
Data Accuracy: It is important to have accurate data when projecting cash inflow to avoid erroneous projections. Some businesses either fail to keep data or have inaccurate estimations of weekly or monthly business transactions, and data inaccuracy can lead to an inaccurate cash flow forecast.
Tax Changes: Businesses should remember to take tax changes into account. While it's prudent to factor in taxes as a business necessity, it's risky to presume that tax obligations will remain constant.
Late Payments: You should aim for consistent, on-time payments. However, the concept may not always align with business realities. For your forecasting to be effective, you'll need to take as realistic an approach as possible. Otherwise, you will obtain unrealistic projections.
Skipping Regular Reviews: Regular review and comparison of projections with real-time performance is key to attaining business goals. Failure to review forecasts and make necessary real-time adjustments can lead to financial problems.
Considering Different Scenarios: Your cash flow report may mislead you to make business expansions without leaving enough residual cash for unexpected expenses. Always use your cash flow forecast to implement strategic financial decisions.
Best Practices for Creating Accurate Forecasts
Here are some best practices that ensure accurate forecasting.
Regular Review: Regularly reviewing and comparing your forecast with your actual performance is a great way to improve your forecast accuracy and reliability. This practice will enable you to see what is and isn’t accurate in your forecast and help you make the necessary adjustments.
Accurate Data Keeping: Data obtained from a previous business year is critical for forecasting the following year’s cash flow. Therefore, you should collect and keep accurate data.
Automate as Much as Possible: Automating your data makes more room in spaces that paper would have occupied. In addition, it allows you to save and back up data, thus making it hard for people to tamper with information.
Technology Solutions That Can Help Streamline the Process of Cash Flow Forecasting
Technology makes everything easier, cash flow forecasting included. There are many ways to incorporate technology while forecasting your cash flow. Below are some examples.
Switch Paper Documentation for Cloud Storage: if you still store all your information on paper, you are taking a huge risk, as paper is prone to damage. Instead, use computers to document and save information. Encrypt this information and back it up for controlled retrieval when necessary.
Use Software Applications for Data Management: Many applications can manage and process data effectively, and you should incorporate them into your cash flow forecasting process. Some examples include apps like Agicap for forecasting, QuickBooks for credit control, and various AI tools for data analysis.
Connect With Experts Online: Technology can help you seek guidance and assistance from business consultants to get the best results. Through the internet, you can share information or book an appointment with experts who will lift the burden from your shoulders.
How to Get the Best Results for Cash Flow Forecasting
To get the best results out of cash flow forecasting, you need to engage the expert services of an accountant or business consultant. With Foreword Companies, you will get the best business consulting services while enjoying mentorship and networking.
This also includes the available professional advice and corporate turnaround strategizing; it's a complete package. Schedule a call now to discover how you can grow your business.
