Why is a Cash Flow Forecast Important?
A cash flow forecast is a vital financial tool that can provide valuable insights into the health of your business. It offers a detailed prediction of your incoming and outgoing cash, allowing you to make informed decisions about your operations and future growth.
Cash flow planning can cover anything from a few weeks to many months. Plan as far ahead as you can accurately predict. If you’re well-established, you might have a predictable sales pipeline and data from previous years. If you’re a new business, you might not have a huge amount of data - so the further out you go, the less accurate your predictions will be.
The Importance of Cash Flow Forecasting
There are two primary reasons why a cash flow forecast is crucial:
Financial Planning: A cash flow forecast helps you understand your business's financial position and anticipate potential cash shortages or surpluses. This information enables you to make informed decisions about investments, expenses, and borrowing. For instance, if you're considering expanding your business or purchasing new equipment, a cash flow forecast will help you determine whether you have the necessary funds or if you need to secure additional financing.
Investor and Lender Confidence: Investors and lenders are particularly interested in a business's cash flow. A well-prepared cash flow forecast demonstrates your understanding of your business's financial health and your ability to manage its finances effectively. It can be a powerful tool for attracting investment or securing loans.
What Does a Cash Flow Forecast Show?
A typical cash flow forecast is divided into two sections:
Incoming Cash: This section includes projected revenue from sales, investments, tax refunds, grants, royalties or licence fees.
Outgoing Cash: This section lists anticipated expenses such as rent, salaries, raw material, assets, bank loans fees and charges, utilities, purchases, tax bills.
The difference between these two sections represents your net cash flow. Ideally, you want your net cash flow to be positive, indicating that you have more cash coming in than going out. However, it's important to note that negative cash flow periods may occur, especially during periods of growth or investment.
You can then keep a running total, from week to week, or month to month, to get a picture of your cash flow forecast over time. Too many negative weeks might spell trouble, and you’ll need to do some forward-planning to make sure you can meet your commitments - e.g. paying salaries, loan payments, and rent. Equally a few positive months might signal that you’ve got money to expand or invest.
How to Use a Cash Flow Forecast
To effectively use a cash flow forecast, you need to understand how to analyse and interpret the data. Here are some key steps:
Accruals vs. Cash Accounting: Choose the appropriate accounting method for your business. Cash accounting records income and expenses when cash is received or paid, while accrual accounting records them when they are earned or incurred.
Opening Balance: Determine your starting bank balance for the forecast period.
Sales Projections: Estimate your expected sales revenue based on historical data, market trends, and sales forecasts.
Receivables: Project the timing of cash inflows from credit sales.
Expenditure: Forecast your anticipated expenses, including both fixed and variable costs.
Closing Balance: Calculate your projected ending bank balance by subtracting total outflows from total inflows.
Tips for Improving Your Cash Flow Forecast
Regular Updates: Regularly review and update your cash flow forecast to reflect changes in your business environment. That will help you identify how well you are on track against companywide targets and adjust your company’s strategies accordingly
Scenario Planning: Many finance professionals build different cash flow forecast scenarios. Traditionally, they include a best-case scenario, worst-case scenario, and a most-likely case scenario. Running different scenarios enables you to proactively prepare strategic plans with your company for any financial deviations. Though it is a good start to prepare for different scenarios, it does not always prepare you for circumstances that are out of your company’s sphere, like geopolitical tensions or natural disasters for example.
Working Capital Management: Optimize your working capital by managing your accounts receivable and payable efficiently. By optimizing working capital, you gain clarity on exactly when you pay counterparties and receive money from them, and how it affects your cash positions over a given period of time. As a result, it allows you to see how working capital affects your cash projections.
Financial Software: Utilize financial software or tools to automate calculations and streamline the forecasting process. There are plenty of tools out there that can help you improve your cash flow forecasts. Though spreadsheets can be a good start, any larger entity with complex technology stacks and bigger teams typically uses more advanced tools that help them run their cash flow forecasts. Some of the more advanced cash flow forecasting tools these days even include predictive analytics and artificial intelligence
By effectively using a cash flow forecast, you can improve your financial planning, make informed decisions, and enhance your business's overall stability and success.
If you would like more information on how to effectively manage your cashflow please get in touch.