Cash is always on the move in all businesses, and cash flow is an integral part of business life — albeit an unpredictable and dynamic one. All businesses, particularly start-ups, face the challenge of ensuring that they manage their net cash flow to avoid depleting their money.

Cash flow forecasting is a process that estimates a business’s future financial position. It ensures that it has the necessary funds to meet future obligations and better manage the existing working capital. A typical cash flow forecast is divided into three essential parts:

  • Beginning cash balance is usually the total cash on hand a company expects to have at the beginning of each month.
  • Cash inflows- the sources of cash a company has coming in each month, including cash sales and receivable collectibles.
  • Cash outflows are the expenses that the business will incur during the period, including payroll, rent, and payment of utilities.

Why is cash flow forecasting important?

It is prudent for companies to create their own cash flow forecasts to better understand their figures that will inform their financial decisions regarding their business. Cash flow forecasts help companies estimate how much money is moving in and out of their business for a set period. This helps companies plan and prepare for potential scenarios while giving a clear picture of where the business stands financially.

About cash flow forecasting models

Cash flow forecasting models use rolling forecasts where the number of periods remains constant (e.g. 12 months, 36 months, etc.). The forecast is ‘rolled’ forward every time there is a month of historical data to input. Most companies use the essential planning tools provided by cash flow forecast models to ensure that their sources of funds and their use provide enough liquidity for future months’ operations. 

A strong cash flow forecast model should:

  • Explicitly model key cash flow drivers

This is so that the cash flow drivers can directly drive the forecast cash flow inputs and help businesses compute revenues.

  • Logically organise the inputs.

This will help the users to understand and quickly update the model.

  • Use different colours for each input section.

Colour-coordinated inputs allow users to distinguish them from other calculated outputs easily. Most models use black for formulas and blue or yellow shading for the inputs.

  • Inputs all inputs at once

To ensure that there are no repeated data, all inputs should be grouped in an assumption section. This makes it easier for users to find, add and modify them.

  • Document sources for the inputs

You can make notes and comments for the inputs to indicate where you pull the inputs from. Use the keyboard shortcut SHIFT+F2

Benefits and drawbacks of cash flow forecasting

Cash flow is a powerful business KPI and a core component of planning and financial management. And as everything in life should be balanced, learning to balance the benefits and drawbacks of cash flow forecasting can help businesses make decisions by carefully weighing all the options.

Benefits of cash flow forecasting

  1. Predict potential problems

Cash flow forecasting gives businesses sufficient time to steer the business in a different direction for problems such as shortages and surpluses. One can plan and prepare for a different course of action to deal with the problem as they arise or steer clear of it altogether when developing a cash flow forecasting system.

  1. Anticipate cash shortages and plan for them

Cash flow forecasting allows the business to identify cash gaps before they affect the business, allowing the owner to arrange for alternative financing or mitigate the problem by cutting down on operational costs.

  1. Decrease debt and reliance on loans

With a firm grasp and understanding of the company’s cash flow situation, the owner can confirm that they have enough funds to cover the expenses and meet payroll without relying on debts or loans.

Drawbacks of cash flow forecasting

  1. Forecasting can be affected by factors outside the company.

Several factors can cause a business’s cash flow to change for better or worse, such as changes in legislation. As anything can happen, a business can be blindsided by random instances of possibility that impact a business.

  1. Inaccessibility to enough data and information affects forecasting

Most successful cash flow forecasts rely on industry trends and historical business information. While this might hold for industry titans, new businesses have the disadvantage of not having access to all this data. Having inaccurate data and the lack of data can lead to disastrous cash flow forecasts.

  1. The guessing nature of forecasting

Forecasting is an educated guess at best, and it could be wrong. It has the probability of being wrong the longer it extends as even the best, and most educated guesses always involve a modicum of probability. This is the biggest disadvantage of forecasting in general.

Cash flow forecasting versus cash flow statements

These two are both financial accounting reports with a few differences. While cash flow forecasting or projections involves looking into the future to predict future cash flows, cash flow statements represent cash flow transactions that have already taken place.

Cash flow statements or statements of cash flows is a report that summarises the changes in balance sheet amounts and income that affect the net increase or decrease in cash and cash equivalent.

The cash flow statement classifies the cash flows into:

  • Cash flow from operating activities
  • Cash flow from investing activities
  • Cash used in financing activities
  • Net increase/decrease in cash and cash equivalents.

Businesses use the information from cash flow statements to assess their ability to generate cash and cash equivalents and the need to utilise the cash flows. Cash and cash equivalents consist of:

  • Cash in hand
  • Cash at bank
  • Short term investments that are highly liquid
  • Bank overdrafts comprise an integral element of the organisation’s treasury management.

Businesses use statements of cash flows to provide important insights about the liquidity and solvency of a company which are vital for the survival and growth of any organisation. It is the third component of a company’s financial statements and is often used in tandem with the other two key reports – the Profit and Loss and the Balance Sheet.

Cash flow forecasting software

Cash flow forecasting involves more than just understanding how much money is in your company bank account. A significant amount of resources go into calculating cash flow, including the object and subjective analysis of the cash flow statement.

This is why companies are relying on sophisticated cash flow forecasting software that enables them to easily and quickly assess cash flows. Larger firms can develop in-house packages that they can customise to fit their needs. 

Smaller businesses, on the other hand, either have to rely on ‘white label’ software provided by third parties and pay for subsequent updates or enter the software as a service (Saas) market where the third party supplies the software, with specific functions such as cash flow forecasting, and its maintenance throughout the contract.

Whatever option a business chooses, there are some key functions that the cash flow forecasting software should have. These include:

Analysis

A good cash flow forecasting software should have the ability to assess future short-term cash needs. The system should be able to automatically analyse the best financial options to maintain high levels of short-term funds to keep the company afloat and stretch the worth of its cash.

Data collection and harmonisation

Can the software pull together relevant data, collate, harmonise and present it reliably and understandably? A fully automated system automatically collects data and positions it in a simple and manageable way for managers to assess, taking the strain off the finance department while making cash flow forecasting more approachable.

Integration with other systems

A good cash flow forecasting software should allow it to link to other system software such as ERP to pull the relevant and accurate data for analysis and review.

Summary 

As demonstrated, a cash flow forecast is a very significant aspect of business life. The most convenient and easy way to stay on top of your business’s incoming and outgoing cash flow is to utilize FP&A software, enabling you to get a real-time overview of your cash flow from any device with an internet connection.