The advantages of cash in business are vast. If you have cash, you can take advantage of opportunities, keep debt low and expand operations. However, if you have negative cash flow, it may indicate a major problem in your operations.
Even a simple cash flow forecast can change the course of a business.
What Is a Cash Flow Forecast?
A common cash flow forecasts definition is: “a projection of a company’s cash flow over a specified period of time.” The forecast will use multiple variables and data input to determine how much:
- Cash is entering the business
- Cash is exiting the business
Past business performance will be used to generate your projected cash flow.
Why Is It So Important [RE1] to Forecast Cash Flow?
Projected cash flow offers many benefits (discussed below), but the main reason that forecasts are so important is that they provide data on how the company will perform. The data itself is important, but it’s even more important for you to use the data to:
- Lower business risks
- Secure financing, if necessary
- Grow operations
If you have a cash flow forecast generated and you’re not using the data to make smarter decisions, the projection will not help you.
Benefits Of Cash Flow Forecasting
Finally, it’s time to look at the advantages of cash flow forecasting and how it helps businesses around the world grow:
Anticipate Bottlenecks
Businesses go through ebbs and flows in the market. You can do everything right and demand can slow and cause you to struggle to maintain cash flow. Bottlenecks in business are common, but cash flow bottlenecks can lead to:
- Unnecessary debt
- Slow business growth
- Downsizing
Business leaders who can anticipate cash flow bottlenecks can work to eliminate them. For example, if the projection shows that you’ll have negative cash flow, you can then work on cost management (more below).
You can use this information to reduce investments during this time or start to let staff go so that you can maintain operations.
Of course, if you notice cash flow bottlenecks that will impact long-term growth, you can take this time to secure financing. It's better to be in a position of power when looking for financing so that you can compare terms and choose the best option than be stuck with the first lender that approves your loan with high interest because you can’t keep operations going.
Plan Investments Better
Investing is how businesses grow. One of the reasons you should do a cash flow plan is so that you can invest in the future. Forecasts allow you to:
- Identify periods of high cash flow where you can invest in growing operations
- Identify times when investing may not be a good option because cash flow is slowing
Cash can also be put aside in reserves so that if your business goes through a slow period, it will have the cash to get through it. Companies, such as Apple, are known to hoard cash so that they can use it to invest or withstand slow periods.
A year ago, Apple had over $200 billion in cash reserves, which it often uses to acquire other businesses, open new offices and more.
Pass Scenarios
What-if scenarios in a forecast are one of the main benefits of running forecast projections. Using a hypothetical example, let’s assume that you plan on releasing 3 new products this year. You can add these products into your forecast, along with expenses for:
- Hiring staff
- Production
- Marketing
- Etc.
Using these figures, you can then run cash flow scenarios to learn what happens to your cash flow if sales:
- Meet expectations
- Miss expectations
- Exceed expectations
Using scenarios, you can make better decisions about the future of your business.
Better Cost Management
Cost management often goes overlooked when profits are high because everything is running well. You can use cash flow forecasts to improve your business’s cost management so that you know:
- Costs of a project
- Expenses of a project
- Revenue earned from a project
You can also maintain better cost management for your organization as a whole using your cash flow forecast.
Better Receivables Management
Accounts receivables that are high indicate that you have delivered goods and services that have yet to be paid. However, these goods and services have been paid for by you, meaning that you had to pay for everything to deliver them, such as:
- Materials
- Manufacturing
- Labor
- Shipping
- Quality assurance
- Etc.
When you run cash flow projections, they provide immense insight into how much of your cash is being held in account receivables. You may find that 50% of the money that you “earned” has yet to be paid for by customers or clients.
You can then use this information to find ways to reduce accounts receivables, such as:
- Automate sending invoices and reminders
- Reduce payment terms for invoices
- Encourage fast invoice payments
You may even need to have a meeting with some clients about their pending payments and let certain clients go because they do not pay their debts on time.
Cash flow bottlenecks can grow out of control when you have money stuck in invoices because the money is not liquid. You cannot leverage the power of cash until it actually hits your bank account.
Cash Flow Forecast Risks
Why is it important to have a cash flow plan? It provides the “potential” outlook for the business. However, there are always risks when running a forecast, which can include:
Not Completely Secure
Your projection may indicate that you have $100,000 in cash at the end of the period or -$100,000 in cash. However, there are always variables that will change throughout the forecast period that must be considered.
A forecast is never 100% accurate.
For this reason, it’s not uncommon for businesses to generate:
- Best-case scenario forecasts
- Worst-case scenario forecasts
Then, a final average will be used to determine the midpoint of these two forecasts, and this is often what the business will use when trying to improve the accuracy of its projections.
Difficult To Plan Long Term
Long-term cash flow forecasts are fun to run because they can show you what your business’s cash flow may be in 1, 2, 5 or even 10 years. The issue with these long-term projections is that they become more inaccurate the longer the forecasting period extends.
For example, the data for a quarter or a year is going to be far better for a projection than anything for a five-year period.
Why?
A lot will change during this time period.
Over the course of five years:
- Costs rise
- Industry trends change
- Competitors rise and fall
- Etc.
If you rely heavily on long-term forecasts, this can be a major risk for your business because inaccuracies arise the longer you attempt to run a projection.
Summary: Reasons Why You Should Make a Cash Flow Plan
The advantages of cash are too high to ignore. Whether you run a startup or have a seasoned business, there are many reasons to create a cash flow plan. If you want to lower your business’s risks, use data to make smarter decisions and grow your operations, it’s time to experience the benefits of forecasting.
Cash Flow Frog is designed to help you run cash flow forecasts using your historical or input data in minutes.
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