In a nutshell, cash flow forecasting is a way of estimating the flow of cash coming in and going out of your business over a given period of time. Cash flow forecasts provide you with the most robust, accurate, and real-time predictive data that will help you spot cash fluctuations in advance and make intelligent business decisions.
You can use a cash flow statement template to track your past, present, and future income and expenses, giving you the insights, you need. It will typically look at incomings, outgoings, loans, sales, expenses; every penny passing through your business for whatever reason should be included in your cash flow forecast.
Cash flow forecasting is an important tool for business planning. It allows you to better understand your cash flows and prepare for potential problem areas. Here are some of the many ways cash flow forecasts can help your business:
The main goal of cash flow forecasting is to help manage liquidity and ensure sufficient cash is there to meet your business’ day-to-day and other short-term expenses and avoid funding issues, ultimately better management of working capital.
Here are some other objectives of cash flow forecasting
Although there are several methods to measure cash flow, these three cash flow formulas make it easier to predict future financial health and better understand how cash is coming in and going out of your business.
Free Cash Flow = Net income + Depreciation/Amortization – Change in Working Capital – Capital Expenditure
Operating Cash Flow = Operating Income + Depreciation – Taxes + Change in Working Capital
Cash Flow Forecast = Beginning Cash + Projected Inflows – Projected Outflows = Ending Cash
The two most sought-after methods of cash flow forecasting are direct and indirect cash flow forecasting. Cash flows and balances are forecasted for short-term liquidity management in the direct sale forecasting and vice versa. The time horizon is short-term (less than 90 days) indirect while longer-term in indirect cash flow forecasting.
Direct cash flow forecasting shows the cash required to fund working capital while indirect cash flow forecasting shows cash required to fund longer growth strategies and capital projects. The direct method includes all types of transactions including credit and cash transactions as well as bills, invoices, and tax. The indirect method uses the balance sheet and profit and loss statements to predict cash flow.
Management of a Cash Flow Forecasting
Remember, without cash, profits are meaningless. In the current situation, it’s critical for you to manage your cash flow. If you can’t manage your cash flow within the first year, there’s a chance you might not survive past the second year.
Here are some smart tips to fix your business’ cash flow problems:
In business, the best way to face uncertainty is to be prepared with the information needed to effectively respond to potential situations. Cash flow scenario models are the process of planning for critical uncertainties that may affect your business’s cash flow in the future. It is created by modelling different hypothetical situations to see how these may affect your business’s future cash flow.
What if you would purchase a business loan? What if you would hire more staff? What if you would open a new office? With cash flow scenario models, you can evaluate different situations and predict their effect on your business goals and future cash flow. You could also create the best case, moderate case, and worst-case scenario models to see their impacts on your business’s cash flow.
Although cash flow forecasting has numerous benefits, it comes with its own set of challenges. Here are some common challenges you might face when developing cash flow forecasts.
Although keeping your cash flow forecast up-to-date is a challenging and time-consuming endeavour, it’s vital for accurate prediction. If you ignore it, your numbers are immediately wrong. So, it’s important to keep your forecasts up-to-date by building them weekly. Regular cash flow forecasts help you enhance understanding of customers and suppliers, help businesses understand the cost of growth, reduce the cost of capital and increase communication with other departments. Doing a little more reviewing can sometimes be the key.