Cash flow is like the streaming blood in the body of a business. However profitable a company becomes and whatever growth trajectory it reaches, cash flow is always a constituent part of its becoming. But what makes a business fully prepared to handle the toy turvy situation affecting the cash flow consistency? Well, this is what is done through cash flow forecasting. A well-engineered cash flow forecast helps a business to maintain liquidity while avoiding crises in contingent situations.
Here in this post, we are going to define cash flow forecasting, its role and advantages, different cash forecasting models, and above all, how to do it.
What is Cash Flow Forecasting?
Cash flow forecasting is the predictive method to precisely tell a business the amount of money that will flow into and out of a business within a specific timeframe. First, we need to understand what cash flow is. Cash flow doesn’t represent business profit. Profit doesn’t always reflect the cash flow since several non-cash items are involved in it. In contrast, cash flow is the actual movement of money within a business system.
By applying a cash flow forecasting model a business can achieve the following:
- It can successfully predict cash crunch or surpluses.
- Based on the cash projection a business can make precise planning of different types of expenses for which cash is required. Some of these expenses are employee payroll or salaries, debt payments, and the purchase of inventory.
- Based on precise cash forecasting a business can make accurate investment decisions, start talent hiring, or run marketing campaigns.
Cash Flow vs. Profit: Why Cash Forecasting Matters?
Now that we have explained what is cash forecasting, we also need to clear the major confusion about comparing cash flow with profits. Even profitable businesses may fail just because of running out of cash.
There are many examples of disparities between profit and cash flow. A business may have registered huge profits as per the sales figure but it can still have zero cash in account due to non-payment of dues or delayed payment from customers. Similarly, a business selling seasonal products may experience a cash crunch in off off-season.
This is where the importance of cash flow forecasting helps mitigate this gap. By leveraging the cash forecasting model well in advance a business can ensure that it has enough cash t for expenses, investment, and growth-focused campaigns.
Benefits of Cash Flow Forecasting
The primary benefit of cash flow forecasting is having sound control over business operations, expansion, talent acquisition, and growth strategies. Let’s explore the key advantages that any business enjoys by doing cash flow forecasting.
- Ensuring Liquidity: Through this forecast, you can easily predict the cash crunch before the crisis leads to losses or emergencies.
- Make Valuable Investment: As a business, you can only invest when you have surplus cash at your disposal. Thanks to this forecasting you can always be cash-ready for expansion or investment.
- Get Valuable Partners: The cash flow statement of a company represents its financial health which lenders and potential investors always assess and rely upon.
- Insurance Against Contingencies: Good cash flow gives protection against calamities and contingent situations like a flood, earthquakes, economic recessions, and supply chain disruptions.
How to Forecast Your Cash Flow: A Step-by-Step Guide
Measuring your cash flow requires the tested and tried method of creating a model. In contrast to common misconceptions, a cash flow forecasting model can be very simple. Here are the steps to forecast your cash flow.
Step 1: Choose The Timeframe
When choosing a timeframe you should consider the following aspects:
- A short-term window that typically lasts between 0 to 90 days focuses mostly on fulfilling urgent needs such as maintaining cash reserves to pay the salaries of employees.
- The Medium-Term window lasting between 3–12 months typically focuses on seasonal goals like paying quarterly taxes, purchasing inventory, etc. –
- Long-term window spanning between 1–5 years mostly serves long or mid-term strategies such as business expansion or buying equipment.
Step 2: Figure Out the Cash Available in Hand
The cash you have in hand is the baseline from where you start. The cash you have in hand allows you to meet expenses and plan for different investment or expansion objectives.
Step 3: Make A Good Estimate of Cash Inflows
In this step, you need to predict cash inflow from different sources such as recovered payment, regular customer payment, sales revenue, cash from loans, cash from investors, tax refunds, and sales of assets. For precise estimation of cash inflows, you need to pay attention to historical cash inflow data of the company over the years.
Step 4: Assessing Cash Outflows
Now you need to assess and calculate all expenses of the company as meticulously as possible. Some of the common expenses t9 considers include fixed costs such as property rent, utility bills, and employee salaries, variable costs like marketing costs, maintenance costs, inventory costs, cost of one-time purchases, loan EMIs, and loan interests. Be as meticulous as possible to not miss irregular or seasonal expenses.
Step 5: Figure Out Net Cash Flow
Now figure out the net cash flow by subtracting total outflows from inflows for a particular period.
Cash Flow Forecasting Models
There are also different cash flow forecasting models out there. You need to pick the model that perfectly addresses your forecasting objective. Let’s have a look at different forecasting models.
- Direct Forecasting: This method is about closely monitoring your actual cash transactions and figuring out the cash flow accordingly. This model is ideal if you want a short window.
- Indirect Forecasting: This forecasting method that considers net income along with all non-cash items like depreciation is preferred by decision-makers and strategists for long-term plans.
- Scenario-Based Forecasting: This model relies on probable factors. For example, if 50% of customers make delayed payments, what will be the cash flow status? This method is more suitable for assessing imminent financial crises or risks.
Beware of These Cash Flow Forecasting Mistakes
Decision makers and stakeholders when carrying out cash flow forecasting often forget contingent situations. Businesses often do not prepare for the worst when there is enough signal for market slowdown. Another common mistake is not to align forecasts with specific market changes or trends.
Ending Notes
Cash flow forecasting allows modern businesses enough room to flex their investment and growth planning muscles. But what matters most is how they make use of sophisticated data visualization tools and predictive insights. Cash flow forecasting as a financial discipline has already gone beyond the Excel sheet. Last but not least, always pay attention to your industry scenario and accordingly, create conditional models to stay ahead of the market risks.
