Long-term cash flow forecasting is an essential component of good financial planning. Cash flow management is a primary focus of many businesses and as such, it is important to create forecasts that examine both short and long-term cash demands. Forecasting is an important financial tool used by decision-makers to ensure that they are steering the business in the right direction. 

It is important to understand how forecasting and budgeting is used in conjunction to provide an organization with both a roadmap and a compass. The budget acts as a guide while various forecasts are used to ensure the business is headed in the right direction. 

In this FAQ we will discuss what a long-term cash flow forecast is, how it differs from a short-term cash flow forecast, why it is important, and the basic steps to take when creating one. 

What Is A Long-Term Cash Flow Forecast?

A long-term cash flow forecast is a type of cash flow forecast that extends beyond 12-months. Typically, a long-term cash flow forecast is three years into the future. The further into the future projections are made, the less accurate they become, therefore long-term cash flow forecasts are used as a general guide by which current cash flow is measured against. 

Once a business creates and implements a budget outlining the future expectations, forecasts are then developed to estimate what the future might look like. As the business moves into the future forecasted periods its performance is measured against the forecast to ensure that it is headed in the right direction. Consequently, new forecasts are sometimes created in response to actual results and other external impacts in the business environment.

Short vs Long Term Forecasting

Most businesses have a need to monitor cash balances closely. Because of this cash flow forecasting is often divided into short and long-term forecasts. This is because there exists a need to understand immediate cash demands and limitations. Liquidity is a primary concern for many businesses and monitoring liquidity is often a regulatory requirement for many companies. 

Short-term cash flow forecasts are always twelve months or less and can even be made weekly or daily depending on the need. For many businesses managing cash balances is an important aspect of their business model. Businesses that rely heavily on cash transactions or are simply transaction heavy typically create weekly cash flow forecasts to ensure sufficient balances are maintained. 

On the opposite side of the spectrum is long-term cash flow forecasting which is technically considered anything beyond twelve months. Performing both short- and long-term cash flow forecasting in conjunction is usually the best approach to ensure adequate cash management.

Why Is Long-Term Cash Flow Forecasting Important?

Long-term cash flow forecasting is a practice that helps management identify if decisions made today will have impacts beyond the immediate future. Understanding future cash flow is an important CPM activity that helps leadership identify risks and potential unforeseen impacts of decisions made in the present. 

Taking the time to forecast cash flow well into the future helps to provide leadership with insight into how investments made into the business today will pay off in the future. It also helps to identify if current credit and collection practices can be optimized or adjusted. 

Perhaps one of the biggest benefits of creating long-term cash flow forecasts is its ability to provide information regarding the servicing of debt. Understanding future liquidity constraints helps to identify credit risks and other impacts on the structure of financing behind the business.

How To Make A Long-Term Cash Flow Forecast

While there are many ways to build financial models it is important to note that a cash flow forecast of any kind is dependent upon certain assumptions. Therefore the first step in creating any financial model is to research and develop realistic and meaningful assumptions. 

Once the assumptions are made, create a short-term cash flow forecast. Always start your forecast with a verifiable balance as the wrong beginning balance will yield an inaccurate ending balance. Here are the two steps to take to build a long-term cash flow forecast:

Step 1: Understand Sources And Uses Of Cash

The first step is to aggregate your sources and uses of cash. Keep in mind this could be different from income and expenses, which might include accrued and non-cash expenses as well as sales on credit.

Step 2: Roll Your Beginning Balance

Start your projection with the ending balance from the prior period and add each source of cash to the balance reducing it by each use of cash for the same period. Be sure to choose meaningful short-term periods. Continue this process for the desired time period. 

Using Datarails, a Budgeting and Forecasting Solution

Datarails’ FP&A software replaces spreadsheets with real-time data and integrates fragmented workbooks and data sources into one centralized location. This allows users to work in the comfort of Microsoft Excel with the support of a much more sophisticated data management system at their disposal. 

Every finance department knows how tedious building a budget and forecast can be. Integrating cash flow forecasts with real-time data and up-to-date budgets is a powerful tool that makes forecasting cash easier, more efficient, and shifts the focus to cash analytics. 

Regardless of the budgeting approach your organization adopts, it requires big data to ensure accuracy, timely execution, and of course, monitoring.

Datarails is an enhanced data management tool that can help your team create and monitor cash flow against budgets faster and more accurately than ever before.