Cash flow forecasting, also known as cash forecasting, estimates the expected flow of cash coming in and out of your business, across all areas, over a given period of time. 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.
The result of cash flow forecasting is a cash flow forecast document which shows your projected cash position based on income and expenses for the selected timeframe. This is an important tool when it comes to making decisions about activities such as funding, capital expenditure and investments.
Cash flow forecast example
Cash forecasting can be carried out for a range of time horizons, but 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 future cash flow is a top priority for any company, as it helps you optimize your cash position, prepare for future cash flow problems, and make better-informed decisions. At the most basic level, a cash flow forecast can estimate 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 forecast statement, 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.
Cash flow forecast challenges
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.
The importance of cash flow forecasting
Focusing on overcoming any challenges you face in putting together a cash flow forecast is time well spent, because the importance of cash flow forecasting in financial planning can’t be overstated. While business owners, C-suite executives, or senior management will generally understand the business’ financials implicitly and may have expectations of profit and loss, they can’t predict the future.
Without using a formal data-led process to forecast future cash flow, it’s almost impossible to predict changes to sales or costs and estimate how much cash your company will have at any given time. That makes it incredibly difficult to make informed business decisions about current or future spend, understand how to plan for change, or confidently pursue business growth.
With the insights that are delivered by a cash flow forecast statement, even with the understanding that they’re not exact, it’s possible to make more intelligent working capital decisions that fuel future growth or protect the business against potential instability.
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.
Creating a cash flow forecast can help businesses to better understand expected cash movements over a selected period of time. This projection of future finances, in turn, allows businesses to make more informed decisions, avoid finding themselves short on cash when they need it, and know how much capital they have to pour into fueling growth.
At its most basic level, a cash flow forecast is essentially a log of expected inflows and outflows of money into your business over a set timeframe. Therefore, creating a cash flow forecast is theoretically as simple as filling out a spreadsheet with all projected income and expenses over that period. However, at enterprise level where there can be thousands of different sources of income and expenses, cash flow forecasts can become much less simple to put together. In these circumstances, it’s often easier to use dedicated cash flow forecasting software.
Cash flow forecasts should contain four main categories of information: expected income, projected dates for when you’ll receive that income, expected costs, and projected dates for when those costs will be incurred. However, at a more granular level, a cash flow forecast will include income from sources like sales, interest, and sale of assets and expenses from sources like materials, wages, and marketing.
Improving the value that a cash flow forecast delivers is best achieved by improving the accuracy with which you forecast future income and expenses. That can be done in a range of ways, but some of the most common include refining your approach to sales forecasting and ensuring you keep perfectly accurate logs of expenses. Most importantly, though, is to compare your previous cash flow forecasts with the actual income and expense data from the same period. This can help you to understand where your forecasting approach works well and where it falls short, leading to gradual improvements to the overall process.