Cash flow forecasting, also known as cash forecasting, is a way of estimating the flow of cash coming in and out of your business, across all areas, over a given period of time. A cash flow forecast shows your projected cash based on income and expenses and is an important tool when it comes to making decisions about activities such as funding, capital expenditure and investments.
Cash forecasting can be carried out for a range of time horizons. A short-term cash forecast may cover the next 30 days and can be used to identify any funding needs or excess cash in the immediate term.
A medium-term cash flow forecast may cover between one month and one year ahead, while a long-term forecast will be used to look at sales and purchases further into the future – between one year and five years ahead or even longer, depending on the nature of the business. The longer the time horizon of a cash flow forecast, the less accurate it is expected to be.
Cash flow forecast example
The following example shows a simple one-month cash flow forecast for a business in the month of January, with net cash flow calculated as the difference between total inflows and total outflows:
Opening cash balance
Net cash flow
Closing cash balance
What is the purpose of a cash flow forecast?
Predicting your cash position is a top priority for any company, as it helps you stay on top of your cash flow, prepare for the future, and make better-informed decisions. At the most basic level, a cash flow forecast can tell you if you will have a positive cash flow (meaning more cash is coming into the business than going out) or a negative cash flow (meaning more cash is going out than coming in) at a given point in time.
Armed with an accurate cash flow prediction, you can minimize the cash buffer needed for unforeseen expenses and make better use of your company’s excess cash. You can also plan ahead for any expected cash deficits and manage FX risk more effectively. What’s more, an accurate and timely projection can help boost the forecaster’s profile and reputation with key stakeholders within the business.
However, companies often find it difficult to forecast their cash flows accurately – particularly if the business operates across a variety of countries and currencies. In order to build an accurate cash flow forecast, the forecaster will need to obtain accurate, up-to-date information from a variety of different sources around the organization. This can result in a number of challenges, including:
Time. Forecasting can be an arduous and time-consuming process, particularly if the forecast is based on spreadsheets and involves manual data collection.
Errors. Manual data collection processes may also run the risk of data inputting errors and inconsistencies.
Lack of co-operation from stakeholders. Internal stakeholders may fail to provide information on time or in the required format – particularly if they do not understand why the forecast is important.
Lack of forecasting tools. Once the required information has been sourced, the forecaster will need to have suitable tools in place to turn the data into a forecast. But without sophisticated tools available, this can be an unwieldy undertaking.
In order to overcome these challenges, companies should consider how they can improve the data collection process and make use of technology to maximize the accuracy and timeliness of the resulting forecast.
In order to streamline the forecasting process, the forecaster needs to ensure that the people who need to provide information understand the importance of the forecast and the level of detail required from them. Another important consideration is the need for executive sponsorship. If senior management demonstrates clear commitment to the forecasting process, stakeholders are more likely to engage with the process and the forecast is more likely to provide value.
Also important is understanding that forecasting doesn’t end once the forecast itself is up and running. The accuracy of a cash flow prediction should also be monitored on an ongoing basis by comparing forecast and actual cash flows. While few forecasts will be 100% accurate, monitoring the level of accuracy achieved by the forecast gives the company the ability to pinpoint any areas for improvement. A feedback loop should also be established so that appropriate action can be taken to address any variances.
Sophisticated cash forecasting solutions can use both live and historical data on the company’s payables and receivables, alongside technologies such as machine learning, to provide fast and accurate near-real-time forecasts. These may take into account not only current purchase orders, payables and receivables, but also behavioral patterns such as invoice approval times.
Visualization tools can help companies understand the forecast quickly and easily, thereby facilitating corporate decision-making. In addition, cash forecasting tools which integrate seamlessly with the company’s ERP instances around the world can reduce the challenges associated with gathering information from disparate sources.