Cash flow issues are one of the primary reasons why businesses fail. Your business may be profitable on paper, but if your cash flow is in the negative, you will struggle to keep operations going. For this reason, businesses forecast cash flow to predict whether they will run out of cash in the near future.
If you’re a business owner, understanding the definition of cash flow forecasting and its benefits is important.
Before we talk about forecasting, let’s look at cash flow in general.
Cash flow is the net balance of cash moving in and out of a business. If your cash flow is positive, it means that you have enough cash to cover your expenses. If it's negative, it means that your business doesn’t have enough funds to make ends meet.
A cash flow forecast is an estimate of a company’s future financial position based on how much cash is flowing in and out of the business over a specific period of time.
Typically, cash forecasting can be done weekly or on a monthly basis. For businesses that are well-established, monthly forecasting will suffice. For new businesses or companies in a volatile financial state, weekly or bi-weekly forecasting is recommended.
Cash flow forecasting can be used for many purposes, including:
Meeting Reporting Requirements
Businesses may engage in cash flow forecasting in order to meet reporting requirements. For example, the organization may be required to have finished projections of the company’s cash positions at certain times of the year. Cash flow forecasting helps them meet this requirement.
For Liquidity Planning
One of the main objectives of cash flow forecasting is to ensure the company has enough cash in future cash reserves to meet short-term obligations to suppliers and creditors. In other words, it’s used for liquidity planning and risk management.
For Scenario Planning
Another objective of cash flow forecasting is for scenario planning. Businesses can look at how their cash flow will be affected in various realistic scenarios. Planning for the best-case and worst-case scenarios allows businesses to prepare for whatever may come. They can also plan for the most-likely scenarios to ensure they maintain healthy cash flow.
To Develop Strategies
An accurate cash flow forecast can provide insight into where your cash inflows are coming from and where your outflows are going out to for specific projects. Having a better understanding of your cash flow on a per-project basis allows you to improve or optimize strategies in the future.
To Enhance Shareholder Value
Shareholders are naturally interested in a company’s cash flow, and forecasts will allow them to see how well the organization is performing. Future cash flows can also impact the value of a business, which is something that shareholders are evaluating regularly.
To Attract More Financing
Cash flow forecasting can also help a business attract more financing. Forecasts help gauge the financial health of your business and its performance. If forecasts are showing positive cash flow, then lenders will be more likely to approve a loan application or extend credit to an organization.
Cash flow forecasts have several components, including:
Cash flow forecasts start with an opening balance, which is a reflection of the business’s current cash position.
An organization’s cash outflows are all the cash that is flowing out for the forecasting period, including:
Any cash that is moving out of your business will be placed in this section. Adding up all of these expenses will give you your cash outflows for the forecasting period.
Cash inflows are cash that is moving into your business from:
Adding up the cash from all of these sources will give you your cash inflows for the period.
Many business owners confuse cash flow and profit. But when you take a closer look at cash flow forecasts examples, you can see that these are two very different things.
So, how is profit different from cash flow? You already know that cash flow is the net balance of your cash inflows and outflows. Profit is the remaining balance when you subtract operating expenses from revenues.
Both profit and cash flow are important when it comes to managing a business’s finances. They both are metrics used to gauge a business’s financial health.
Now that you have a better understanding of what cash flow forecasting is and how it differs from profit, let’s look at the advantages of creating a cash flow forecast.
There are many advantages to creating cash flow forecasts. It could be argued that cashflow forecasting is essential to preserving the financial health of your business.
Let’s look at some specific advantages of forecasting cash flow for your business.
One of the main reasons businesses forecast cash is because it allows them to predict future cash positions.
Having an understanding of what your cash flow may look like in the near future will allow you to prepare yourself for what may come and to plan your next moves.
Another major advantage of cash forecasting is that it can help make growth more predictable and stable.
Forecasts give you some insight into the future, and you can use this information to make more informed decisions. For example, if your forecast shows an influx of cash in the near future, you can plan to invest in growth or decide to save that cash for future use.
Cash flow forecasting can also help you tame growth that may be getting out of control. Yes, growth is good, but it can also be a double-edged sword.
On the one hand, profits are increasing. On the other hand, you need more cash to meet demand. If your cash flow can’t keep up with growth, forecasting can help you take action before the problem escalates into a more dire situation.
Many business owners take out loans to fund the launch of their business or to expand their operations. If your business is in debt, cash flow forecasting can help you create a plan to be debt-free faster.
When you understand your cash position in the future, you can ensure that you have enough cash to cover your debt payments. If your forecast shows a cash shortage, you can make plans now to avoid that shortage and ensure that your payments are made on time.
The sooner your business gets out of debt, the better. Fewer liabilities mean that you will have more cash to either invest in growth or save for slow periods.
Projected cash flow can help you avoid crippling cash shortages that may otherwise shut down your business. Cash flow forecasts and projections can help you identify cash gaps and predict shortages before they happen.
Having advanced notice of cash shortages means that you can do something about it now before it spirals out of control.
A cash shortage is when your business doesn’t have enough cash to cover operating costs. In other words, your expenses are exceeding your income. Cash shortages can occur for a variety of reasons, including:
The good news is that cash flow forecasting can help resolve most of these issues. When you’re aware of potential cash gaps, you can take action now through one or more of the following:
Cash flow forecasting can help you plan for and avoid cash shortages. But they can also help you make the most of positive situations.
Let’s say that you have a forecast cash flow example showing a cash surplus. Having advanced notice of that surplus gives you time to plan for how you’ll make the most of it.
Surplus cash can be reinvested in the business for growth or even used to repay loans. But without proper cash flow forecasting, it will be much harder to identify a cash surplus and may make it more difficult to take full advantage of it.
Businesses can also use cashflow forecasts to engage in scenario planning and answer “what if” questions that affect the future of their business. For example:
Scenario planning can help you prepare for different situations your business may find itself in, such as declining or even increasing sales. It can also help you determine whether now is a good time to make certain decisions.
Understanding how to do a cash flow projection and using it for scenario planning can help you make the right decisions at the right time. As you know, scenario planning can help you see what might happen to your cash flow if, for example, you hired new staff or expanded to a new market.
Perhaps your latest forecast shows that you may be on the verge of a cash shortage in the next few months. Armed with this knowledge, you can make the decision to hold off on your plans for market expansion or hiring new staff until your cash flow improves.
Alternatively, if your cash flow forecast shows a surplus in cash, then now may be a good time to move forward with market expansion or hiring.
Cash flow forecasting gives you a glimpse into the future so that you can make the right decisions at the right time.
Learning how to estimate future cash flows can help you keep a close eye on or keep track of overdue payments.
Having to chase invoices and track down payments can be challenging and stressful. Late payments also have a negative impact on your cash flow and make it more challenging to stay afloat.
Cash flow forecasting can give insight into late payers and how they are impacting your cash flow. This will then give you time to take action and address the issue. For example, you may start charging a late fee for late payments, requiring partial payments or adjusting your payment terms.
Offering your customers or clients more payment options can also help address issues with late payments. Online payment systems are incredibly convenient and may allow you to overcome those overdue payment issues more easily.
All business owners have revenue targets and goals, and a timetable to reach those goals. Cash flow forecasting can help ensure that you’re on the right track and determine when or if you’ll reach those goals at your desired time.
With forecasting, you can see the breakdown and impact of your budgeting efforts, and whether you’re over or under budget.
Being able to take a closer look at the cash going into and out of your business will help you create more accurate budgets in the future. The more accurate your budgets, the easier it will be to reach your goals within your desired timeframe.
Some business owners look at a cash flow projection example and immediately feel overwhelmed. Cash flow forecasting is actually much simpler than you might imagine – if you use the right tools.
Automated tools like Cash Flow Frog make it quick and easy to create cash flow forecasts for your business.
Using data from your accounting software allows you to create more accurate cash flow forecasts and projections. It also reduces the risk of human error, which is common with manual forecasting.
Tools like Cash Flow Frog eliminate the hassle of creating cash flow forecasts, saving your business valuable time and providing even more valuable insight into the financial health and performance of your business.
Now that you understand the benefits of cash flow forecasts, it’s time to start making your own. Use your cash flow forecasts to make more informed decisions and plans for your organization’s future. You can also use your forecasts to help secure additional funding from loans and investors, or to engage in scenario planning so that you can plan for the future.
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