What is cash forecasting?
Cash flow forecasting is the process of estimating cash flow for future periods in order to determine the financial position of the company.
As the founder of your company, you likely know this. But predicting future revenue and expenses serves various purposes. At its core, it’s performed to ensure the business is able to meet its obligations to creditors. When leveraged effectively, forecasts can drive your business forward.
How to forecast cash flow
Components in a forecast cash flow
The cash flow forecast is the sum of the expected cash outflows and inflows. Outflows are generally payables for salaries or other expenses, while inflows can be revenue payments from customers, external investment or even financing from a bank.
A Cash Flow Forecast simple example
Imagine that you are the founder of an industrial design agency in its early stages. Your main clients are major corporations with inflexible billing and payment terms (30 days net, after delivery of a work package). Simply put—the agency doesn’t get paid before work is complete.
The agency is small but sales are growing. Unfortunately, the company has not yet reached a size or order velocity to keep a constant cash inflow. In other words, it’s boom or bust. There are months with little or no revenue coming in, and others where the company is getting paid for several months worth of effort.
As an agency, your monthly expenses are relatively stable. A few salaries to pay, some subcontractors, and expenses for rent, utilities, and equipment. But because much of the effort is performed upfront, it’s challenging to be sure that expenses are always covered by revenues.
To ensure you have enough cash to bridge those dry months, you’ve decided to seek outside investment, or secure a line of credit from the bank. To accomplish this goal, you’ll need a cash flow forecast. Any potential lender or investor will want to see that over the long-term you are planning to be cash flow positive.
In addition to helping secure outside funding, establishing a regular cash flow forecast will also have added internal benefits. It will aid your growth planning, and it will also help you answer important questions like: when can you afford to hire additional employees? At what point will you be consistently cash flow positive?
Because you don’t yet have software in place, your head of finance will need to collect the data and generate the cash flow forecast manually. They assemble the expected invoicing (and payment) schedule from the sales and operations teams to determine the cash inflows and make a summary of the known cash out-flows.
Now, armed with your cash flow forecast and the knowledge that you need a software tool for regular cash flow forecasting, you’re ready to talk to the bank.
Why is cash flow forecasting valuable
The core idea behind implementing a cash flow forecast is to help your business maintain sufficient (but not excessive) liquidity. This means having enough cash to meet your obligations without holding onto excess funds, ensuring smooth and ongoing operations.
Additionally, for mission-driven founders there may be other strategic reasons behind maintaining a cash flow forecast. It can also be used to help the company:
- Define a plan to reduce debt or interest
- Perform strategic short- or long-term planning
- Determine acceptable payment terms with customers
- Make decisions on how to finance desired growth or necessary investments
- Allows for better planning of financial resources to ensure that cash flow supports your mission-related initiatives and goals.
There is a common misconception between cash flow and profitability, and often these terms are used interchangeably. If you miss to forecast your cash flow there is a risk to be profitable and still struggle with cash.
You could find yourself facing cash flow issues that make it difficult to cover day-to-day expenses, or the uncertainty of cash availability might create significant stress and impact your strategic decision-making.
Without clear insights into your cash flow, planning for growth and scaling operations becomes a challenge, potentially jeopardizing both your business mission and sustainable growth.
Choose a cash flow forecasting method
Your cash flow forecast can be created using either the direct or indirect method.
Direct cash flow versus indirect forecasting method
Cash flow forecasting common mistakes and challenges
Before you begin your cash flow forecasting, it’s important to be aware of common mistakes and challenges. By knowing these in advance, you can address potential issues early and ensure a smoother, more successful process. This is also an opportunity to align your mission with your financial goals and start off strong. Listen to this podcast episode in which we discuss Five Common Mistakes in Forecasting Cash Flow.
It is also important to understand the challenges associated with some of the “standard” approaches to cash flow forecasting.
1.High effort
Especially at larger, multi-site organizations, the cash flow forecast requires lots of input from multiple sources. The process may rely on shared spreadsheets and not follow a systematic process. This drives a tendency for errors and makes consolidating inputs challenging.
2.Lack of awareness
Employees and stakeholders may not understand the purpose and importance of having a solid cash flow forecast. This inhibits buy-in, especially when they perceive limited tangible benefits to their daily work.
3.Low value to individual stakeholders
For an accurate forecast, the perception persists that a massive amount of manual inputs are necessary. This means the cash flow forecast requires considerable effort on the part of individual sites or business units.
On the other side of that, there’s a feeling that it’s a kind of “black box” reporting. Lots of effort and information is submitted, but there is rarely any feedback.
4.Difficult consolidations
With multi-site organizations, intercompany topics and multiple currencies present challenges for consolidating the cash flow forecast. This is of course magnified if the company is not using software or systems but trying to do everything through spreadsheets.
Furthermore, linking the short-term and long-term forecasts to present a cohesive future picture of the business has its own challenges.
5. Misalignment with mission
When crafting forecasts for your mission-driven business, prioritize your social impact alongside financial goals. By aligning your financial projections with your mission, you ensure that resource allocation and decision-making are focused on driving both profitability and positive change. This holistic approach keeps your vision central to the forecasting process.
Keys to accurate cash flow forecasting
1.Securing organizational buy-in
Because of the challenges presented by cash flow forecasting, it’s important to have buy-in from stakeholders at all levels. Sponsorship from top executives for the initiative can go a long way towards increasing acceptance.
Making sure the teams are well educated on the purpose and importance of the cash flow forecast can also drive motivation and buy-in. It also helps to have the cash flow forecast generate easy to understand visuals. A chart of the future cash flows is more easily understood by the team than a large spreadsheet table.
2.Focus on the big picture
Finding the right balance between accuracy and precision can go a long way both for motivating the team and deriving more value to the organization. Although it depends on your business model and the environment you operate in, long-term accuracy is often preferable to short-term precision.
3.Automated and easy-to-use systems
Anything you can do to eliminate sources of error will improve the accuracy of your cash flow forecasting. Reduce manual input to a minimum and use systems and software tools instead of spreadsheets.
Linking your cash flow forecast with your existing reporting will further simplify your cash flow forecasting process. This way, with each change to your actuals and forecasts, it remains constantly updated.
4.Continuous variance analysis
One of the best ways to make your cash flow forecast more accurate is continuously performing variance analysis. Regularly checking actual vs. forecast, forecast vs. forecast and forecast vs. historical trends will help the organization learn. Processes will be improved through this trial and error and over time the forecasts will become more accurate.
5.Get the proper resources to ensure a great cash flow forecasting process
If you’re ready to move away from complicated spreadsheets and towards a software tool, Jirav can help. You can finally stop worrying about manually updating massive excel files to get your cash flow forecast right.
Another resource to consider would be hiring a fractional CFO. This resource would help you free you up to focus on making decisions and working on your business. A fractional CFO offers the expertise of a full-time CFO on a part-time basis, making it a cost-effective solution for businesses seeking to elevate their forecasting capabilities.
You might be wondering
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