Cash flow modeling is a process businesses use to project or forecast cash movements through a given future timeframe. It helps them understand potential inflows and outflows in more detail, enabling an optimized approach to working capital management.
There are lots of ways to build a cash flow model, with the complexity of the model influenced by the number of unique inflows and outflows. However, most models include an analysis of revenue, expenses, capital expenditure, financing activities, and taxes.
Analyzing how these inflows and outflows have balanced against each other in the past helps businesses forecast what their cash flow position might look like in the future, and how it could be affected by various dynamic circumstances.
This is critical for businesses that want to make the most of their available capital. For example, if a cash flow model reveals that, under expected circumstances, the business will have a large cash surplus, senior leaders can plan to use that surplus capital to fuel further growth.
Cash flow model vs cash flow statement
A cash flow statement provides a historical view of a company’s cash in and outflows, typically for a past quarter or year. It details the cash movements that were made in the statement period – including operational, investing, and financing costs and revenue – to give stakeholders a clear view of actual financial performance that they can use for future decision-making.
In other words, a cash flow statement is an analysis of real cash movements that have already happened. In contrast, a cash flow model is a predictive, forward-looking assessment of how cash might move in the future. It’s based on historical data but is still fundamentally speculative.
An example cash flow model
Cash flow models can be extremely complicated and detailed, but we’ve put together a simple example below to help illustrate what a rudimentary cash flow model looks like.
This example makes the following assumptions:
Starting cash balance: $10,000
Monthly sales growth: 10%
Monthly recurring expenses: $3,000
Loan received in month 1: $5,000
Loan repayment: $1,500 per month
One-time investment: $6,000
Month
Starting cash
Inflows (sales)
Loan received
Outflows (expenses)
Loan repayment
One-time investment
Ending cash
Month 1
$10,000
$5,000
$5,000
$3,000
$0
$0
$17,000
Month 2
$17,000
$5,500
$0
$3,000
$1,500
$0
$18,000
Month 3
$18,000
$6,050
$0
$3,000
$1,500
$6,000
$13,550
The assumptions made represent potential scenarios that the business expects with a certain degree of probability. Businesses can create cash flow models based on various assumptions to get a broader picture of how their cash flow might be affected by diverse internal or external events.
How to build a cash flow model
Building a cash flow model can range from being a relatively simple activity to an extraordinarily complex one, depending on the nature and size of your business. The below step-by-step guide offers a quick way to build a rudimentary cash flow model suitable for small businesses:
Establish a timeframe: The first step in building a cash flow model is to decide what timeframe you want to analyze potential cash flows over. Bear in mind that, generally speaking, the longer the period you’re trying to model, the less accurate your forecasts will be.
Gather historical data: Cash flow models rely on a baseline of historical data, from which you can determine realistic assumptions for future cash flow. Pull together a sample of relevant data covering your inflows and outflows over the last three months, for example, drawing from your cash flow statements and other financial records.
Create modeling assumptions: The data you’ve collected should help you identify trends in your inflows and outflows that you can use to create assumptions, like the 10% monthly sales growth used in the example above. At an advanced level, you can also make broader assumptions about external factors that might affect your model, like changing interest rates influencing borrowing costs.
Input inflows and outflows: With your historical data collected and forward-looking assumptions made, you can input your estimated inflows and outflows for the model timeframe. If your timeframe comprises multiple distinct periods (like months), make sure to calculate the cash balance at the end of each period.
Adjust for various scenarios: Creating your first cash flow modeling scenario will give you a useful indication of how your cash flow might change under the circumstances you most expect to unfold. However, adjusting your assumptions to forecast cash flow in other eventualities will give you a broader view of what might happen.
Larger businesses that have to consider a vast number of factors will generally use dedicated cash flow modeling software to handle the task.
Benefitting from ERP integration, this software can create automated cash flow models that take diverse factors and assumptions into account, providing much richer detail. This helps enterprise-level businesses make better financial decisions that account for various potential situations.
Why is cash flow modeling important?
Cash flow modeling is essential for businesses that want to improve their approach to working capital management. With a clear forecast of future cash inflows and outflows, you can anticipate potential periods of cash shortages or surpluses.
On a basic level, this ensures that you can avoid ever falling short of your ability to meet basic financial obligations. But, more broadly, it enables better financial planning which allows you to make the decision to build resilience or invest in growth at the right times.
If cash flow models predict a shortfall in a given month, for example, you can delay discretionary expenses or seek short-term financing ahead of time to avoid liquidity issues and ensure normal operations can continue.
If it indicates an upcoming surplus, on the other hand, you can use your working capital strategically to fuel growth by increasing production, investing in R&D, or making investments, for example.
The information that cash flow models provide can prove invaluable in bringing efficiency to working capital management, helping your business survive when things get tough and thrive in comfortable times.
FAQs
Flexible Funding 2.0 is designed to help you meet your short-term cash objectives. Use Flexible Funding when you need to:
• Make DPO or CCE improvements for financial reporting
• Free up cash for an unplanned initiative (not forecasted)
• Avoid running short on cash payment accounts (due to early payment demand)
• Leverage a low-risk investment option for idle cash
• Maneuver as market conditions shift
• Improve supplier relationships with access to reliable cash flow
Generally speaking, no. Flexible Funding offers a blended experience of Taulia’s Supply Chain Finance and Dynamic Discounting solutions. Whereas Supply Chain Finance permits one early payment offer per day, Dynamic Discounting presents multiple offers on a sliding scale the user can review on a digital calendar. Selecting fixed or variable-rate financing with Dynamic Discounting will influence whether suppliers receive one or multiple offers per day in certain situations when Flexible Funding is activated. Consistent pricing between funding sources — structured in advance through collaboration by all parties — also ensures a unified experience for suppliers.
Rate parity concerns the consistent cost of supplier financing between funding sources. Traditionally, companies have sought to maximize their yield on dynamic discounting while insisting banks keep their margins thin on accelerated payments for suppliers. This rate disparity incentivizes suppliers to “shop” for the best price when both funding sources co-exist in a Flexible Funding-enabled program. A better approach is fair and consistent pricing between funding sources so that suppliers feel like they get a good deal on needed liquidity and buyers optimize the return on their investment with high supplier participation.
Cash flow modeling helps businesses project future cash flows. Learn how it works and why it’s important in our full guide to cash flow modeling.
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