Cash flow refers to the amount of money that goes in and out of a business. Maintaining a good cash flow is essential for a business’s financial health. However, in order to ensure good cash flow, businesses need to have an estimate of their money. This requires knowing how to navigate cash flow forecasting.
This article will cover the essential techniques and benefits of effective cash flow forecasting for businesses.
Understanding Cash Flow Forecasting
A cash flow forecast estimates the flow of money going in and out of a business over a specific period. It is crucial in financial planning and decision-making.
For an accurate cash flow forecast, it is essential to develop an accurate and thorough assessment of its essential components, including:
- Cash inflows
- Cash outflows
- Net cash flow
Cash Inflows
Cash inflow is the cash coming into the business. As part of its cash flow forecasting process, businesses should take into account every source of income if they want accurate forecasts. The most common things that count towards cash inflows generally include:
- Sales revenue – the primary cash inflow source for any business.
- One-time sales – sometimes forgotten by businesses in their forecasts.
- New funding – an essential cash inflow to consider as part of planning for future investments. No matter the source, if any additional funding is part of future plans, it should be included in the cash flow forecast.
- Asset sales – another form of cash inflow. Often, when businesses purchase new equipment, they sell their old equipment. These sales should also be part of the forecast.
- Interest – businesses have money sitting in their bank accounts that gains interest. If the sum is higher, the interest could be a significant amount of cash.
Cash Outflows
In contrast to cash inflow, cash outflow is the money going out of a business. Like with cash inflows, when accounting for a cashflow forecast, businesses should consider every source of cash outflow. The most common cash outflows often include:
- Daily expenses – the most obvious example of cash outflows. These may include things like utilities, loan payments, payroll, etc.
- Buying assets – as we mentioned, asset sales should be included as a cash inflow. But if the business also plans to spend the money on purchasing new assets, they should include the plans as cash outflow.
- Smaller fees – sometimes forgotten about, should be included in a business’s cash flow forecasting.
- Tax payments – businesses should also add their estimated tax payments to their cash flow forecast.
Net Cash Flow
A business’s net cash flow is the difference between all of the business’s inflows and outflows. The estimated net cash flow is typically considered a key indicator of the business’s financial health.
Calculating net cash flow is done by subtracting the estimated cash outflow from the total cash inflow over a particular period. The formula looks like this: “Net Cash-Flow = Total Cash Inflows – Total Cash Outflows”
Essential Techniques For Cash Flow Forecasting
To create an effective cash flow forecast, businesses can use essential techniques like the following:
- Historical data analysis: Analysing the historical cash flow data is essential for accurate forecasting. It allows businesses to assess current financial health compared to the past.
- Creating accurate cash flow projections: Accuracy in financial projections is vital for effective cash flow forecasting and decision-making. By analysing data, trends, and benchmarks, a business can forecast future revenues and expenses.
- Scenario planning: Business should plan for unexpected expenses and possible emergencies in its cash flow forecast. It is wise for businesses to create both worst-case and best-case scenarios in their forecasting.
- Integrating forecasts with budgeting: When creating the budget, businesses should keep in mind their cash flow forecasts and integrate them properly. Because the forecasts are made based on existing components, they can help accurately project where the budgets may be spent.
- Utilising forecasting tools and software: The best way to ensure an accurate cash flow forecast is by utilising technology like forecasting tools and software. With the right software and tools, the possibility of human error is eliminated with technology.
Benefits Of Cash Flow Forecasting
- Improved financial planning: An accurate cash flow forecast can allow businesses to achieve better financial planning without worrying about financial stability.
- Enhanced liquidity management: When businesses know they have readily available cash, there’s a high chance of having better opportunities to manage their funds and utilise them when needed.
- Risk mitigation: With future planning and forecasting, businesses may be able to mitigate risk more easily thanks to future predictions.
- Strategic growth planning: An effective cash flow forecast can also give businesses the benefit of strategic growth planning by enabling them to seize investment opportunities.
Documents Needed For Cash Flow Forecasting
If businesses want their cash flow forecast to be accurate and effective, they must analyse information from the right documents. A cash flow forecast usually requires the following documents:
- Historical financial statements
- Sales and revenue data
- Budget plans
- Bank statements
- Budget reports
- Invoicing records
- Expense reports
Frequently Asked Questions
How often should a business update its cash flow forecast?
How often a business updates its forecast varies depending on its needs. Depending on whether the business is conducting a short-term, medium-term, or long-term forecasting, the frequency is different.
- Short-term forecasting covers the upcoming 30 to 60 days.
- Medium-term cash flow forecasting generally covers the current fiscal cycle or a rolling 12 months.
- Lastly, long-term cash flow forecasting concentrates on predictions beyond a year.
What are common mistakes to avoid in cash flow forecasting?
When conducting cash flow forecasting, businesses often make mistakes. The most common of which are often the following:
- Not updating cash flow forecasts regularly
- Neglecting cash flow projections
- Overestimating revenue
- Not utilising tools and software
- Inaccurate data
- Failing to consider different scenarios
Conclusion
A cash flow forecast is an essential part of maintaining a business’s financial health and making plans for future growth. Cash flow forecasting allows businesses to estimate the flow of cash going in and out of their business and make accurate predictions about their financial situation in the future.
