Cash flow is the lifeblood of every business. If your business isn’t generating enough cash, you won't keep your doors open for long. To stay one step ahead and be proactive about cash shortages, it’s crucial to engage in cash flow forecasting.
If your business is new to forecasting, it’s important to understand how the process works, the best practices and potential challenges and pitfalls.
What is forecasting? Cash flow forecasting estimates the flow of cash into and out of a business over a specific period of time. Forecasts give businesses a glimpse into the future of their cash positions, allowing them to predict shortages and surpluses.
Armed with this knowledge, businesses can take action to avoid moving into negative cash flow territory or generate returns on a surplus.
Forecasting plays an important role in running a business, and it comes with many advantages.
Businesses that don’t engage in cash flow forecasting are at a major disadvantage. Without visibility of your future cash flow, it can be a challenge to make decisions about hiring, launching new products or investing in growth.
Some of the many benefits of cash flow forecasting include:
Most businesses will seek financing at some point, whether it’s for growth or to stay afloat during periods of cash shortages.
Lenders will want to see a cash flow forecast as part of the application process. Having a history of forecasts will make it easier to apply for the financing you need.
Forecasting can help predict seasonal fluctuations in cash flow, which is crucial for businesses that have busy and slow periods.
The insight provided by forecasting allows businesses to plan for periods of lower cash flow and take action now to ensure there’s enough cash to stay afloat during these times.
Another big advantage of forecasting that’s often overlooked is the ability to predict cash surpluses. When you have excess cash, it’s important to make that cash work for you.
Cash flow forecasting allows you to predict these periods and invest at just the right time to accelerate growth.
On the other hand, cash flow forecasting will help you anticipate cash shortages and act accordingly. Even for non-seasonal businesses, there may be periods where cash flow is lower than usual.
Being able to predict these periods allows you to take action now, so you can potentially avoid a crippling shortage.
Now that you understand the benefits of forecasting, you may be wondering how it works. Before we dive into forecasting methods, let’s look at the components that make up a cash flow forecast.
There are several components of a forecast, including:
You'll also want to consider market fluctuations. For example, if sales are 20% higher during Q4 based on historical data, you’ll want to include this variable in your forecast.
Cash flow analysis can include multiple techniques and methods. You'll need to sit down with accounting to better understand which method is right for your operations:
Once you choose your cash flow method, be sure to follow the best practices below.
Monitoring your business cash flow is not enough. You need to follow best practices when running each forecast to ensure that it benefits you the most. Some of the best practices that you should be following are:
Technology allows you to experiment with your forecasts and will empower you to run reports often to have full control over your free cash flow.
Manual forecasts are a thing of the past outside of newly started companies that are trying to run preliminary figures for their business. If you have a business that is operating already, you can use technology that:
A tool like Cash Flow Frog puts the power of forecasting into your hands with the ability to add scenarios and variables to learn what small changes can mean for your forecast.
You can also use tech to run forecasts a year or two into the future or daily so that you have 100% control over your cash flow.
Forecasting any business’s finances is challenging and comes with its own pitfalls. Investing in cash flow forecasting tech is something we highly recommend because manual calculations take a lot of time and resources.
And if you do manual forecasts, the risk of error is also higher than using software or cloud-based solutions.
Manual forecasting's biggest drawbacks are corrected with automation, including:
Automation does a better job, faster. Small businesses can even use automation to run daily cash flow reports, which allows for granular control over their forecasts.
Cash flow forecasting is utilized by every Fortune 500 company in the world. Projecting your cash flow will empower decision-makers to guide the business towards its goals. If the forecast shows a surplus, you can hire new employees or invest in other key areas of operations.
When cash flow falls short, you can secure financing options, such as a line of credit or a loan to cover overhead.
If you’re not using forecasts to propel business growth, you should begin today. Utilizing the right technology makes it fast and easy to see what future sales may look like day-to-day, week-to-week, month-to-month or quarter-to-quarter.
You may be interested: