A Detailed Guide to Cash Flow Forecasting

27 March, 2024
Tom Mercer

Tom Mercer

8 minutes
cash flow forecasting

While it’s impossible to predict the future with 100% certainty, a cash flow forecast will help you estimate how much cash will be moving in and out of your business in any given time period. Not only does this give you a better picture of where your company is financially, but it will help you prepare for a variety of potential scenarios.

In this guide, we’ll cover how cash flow forecasting works, the benefits and challenges of using it, and tips to help you manage healthy cash flow in your own business.

What is cash flow? 

Cash flow refers to the movement of money in and out of a business during a specific period of time. It represents the net amount of cash generated or consumed by the business’s operational activities, investments, and financing activities (i.e. your cash position).  

Positive cash flow occurs when the incoming cash exceeds the outgoing cash, indicating that the business is generating more cash than it is spending.

Conversely, negative cash flow occurs when the outgoing cash exceeds the incoming cash, indicating that the business is spending more cash than it is generating.

Positive cash flow is essential for the financial health and financial stability of a business, as it ensures the availability of funds to cover operating expenses, investments, debt repayments, and other financial obligations.

Efficient financial planning is crucial for maintaining liquidity, supporting business growth, and sustaining long-term profitability.

What is cash flow forecasting?

In a nutshell, cash flow forecasting helps you plan for the future. It is a process that estimates your business’s future financial position and ensures you have the necessary amount of cash to meet future obligations and better manage working capital. 

First things first, you need to know what a cash flow forecast is. 

In a nutshell, cash flow forecasting helps you plan for the future. It is a process that estimates your business’s future financial position and ensures you have the necessary amount of cash to meet future obligations and better manage working capital. 

The old adage goes that you’ve got to plan for the worst but expect the best. 

Cash flow forecasting lets you prepare for a variety of favorable or challenging scenarios by focusing on the revenue you expect to collect and the expenses you expect to pay. This can help you make informed decisions as well as anticipate any big cash movements or cash shortages.

A typical cash flow forecast should include three essential pieces:

  • Beginning cash balance: The total cash on hand you expect to have at the beginning of the month.
  • Cash inflows: The sources of cash you have coming in each month. This could include cash sales, online sales revenue, or receivables collections.
  • Cash outflows: The expenses your business will incur during the period, including utilities, loan payments, rent, or payroll.

What are the benefits? 

Cash flow forecasting can benefit all businesses, not just large, established companies. It’s an essential process to help with the following:

  • Plan for the future: As you evaluate trends and potential situations, this helps you visualise what an increase or decrease in sales will look like on your cash balances. This helps plan your staff hires, owners pay levels and amount available for marketing. 
  • Predict potential problems: Cash forecasting allows you to predict shortages and surpluses in the upcoming months. You can predict short months to an extent and plan for those months by establishing a line of credit, or enforcing receivable collections to help avoid these issues.
  • Decrease reliance on loans and credit card debt: When you have a grasp of your cash flow situation, you can confirm that you’ll have enough money in the bank to meet payroll, pay suppliers, and cover expenses without relying on debt. 

What’s the difference between corporate and entrepreneurial cash flow forecasting?

Corporate cash flow forecasting typically involves larger, established businesses with complex financial structures and formalized, structured approaches, often using sophisticated financial models and software. These are long-term forecasts that include long-term planning for key activities like mergers and acquisitions. 

In contrast, entrepreneurial cash flow forecasting is more common among startups, ecommerce businesses, or small businesses, relying on simpler methods like spreadsheets and focusing on short-term planning and immediate cash flow projections. These cash forecasts are more agile and flexible, often prioritizing key cash flow drivers or planned big capital expenditures over detailed departmental projections. 

How do ecommerce businesses use cash flow forecasts? 

To get started, it is important to establish basic cash flow management processes, like reviewing your cash flow statement, income statement (A.k.a. as your P&L), and balance sheet as a foundational step.

Pro Tip: This is where cloud accounting software, like Xero, as well as expense management software. like HubDoc, is helpful since it allows businesses to track expenses, income, and upcoming payments, providing valuable insights into short-term cash obligations.

Regularly reviewing cash flow performance, financial statements, and short-term forecasts is essential for businesses to anticipate upcoming financial commitments and adjust spending accordingly. By dedicating time to analyze cash flow data and trends, you can identify patterns and anticipate cash flow fluctuations, particularly for seasonal businesses or during peak sales periods like Black Friday.

Moreover, building on short-term forecasts with planned expenses and historical data empowers businesses to make informed decisions and mitigate risks (like a cash shortfall) effectively. This includes identifying areas where expenses can be reduced, adjusting the timing of activities to align with when you may have extra cash,, and proactively accruing funds for future expenses.

How to build out different cash flow forecasts 

When you are first starting out, we recommend creating three different financial scenarios: the best case, moderate, and worst-case models. 

During uncertain times, working out multiple scenarios in a cash flow forecasting model comes in handy. For example, you could use the model to predict what needs to happen if your business revenue shrinks by 50%. You could include a best case, moderate case, and worst-case scenario for reducing labor costs. In the worst-case scenario, you evaluate the impacts of laying off several team members. The moderate may involve reducing hours to three days a week. And, the best case could be if you don’t lay off anyone at all.

Using cash flow forecasting, you could see the financial impact of all three scenarios. You may have thought you needed to lay off your team, but instead find that your business can sustain the reduced hours of the moderate scenario instead.

Pro Tip: During times where variables are shifting quickly like during a recession, you should be updating or reviewing cash flow forecasts on a regular basis – at least monthly but preferably weekly. When you are frequently monitoring your cash flow forecast, it will help you look for warning signs like downward trending revenue or increasing expenses.  

When you are first starting out, we recommend creating three different financial scenarios: the best case, moderate, and worst-case models. 

Understanding cash flow forecasting challenges 

Cash flow forecasting can be extremely beneficial for the businesses that utilize it, but it comes with its own set of challenges. Here are some of the challenges you may run into with this type of forecasting:

  • Uncontrollable external factors: Forecasts are predictions and at the mercy of unforeseen factors, like a slow down in the economy or public health emergencies. These unpredictable factors can significantly impact expected cash flow, and that means companies need to adapt and adjust to current market dynamics. 
  • Limited or inaccurate data: Your forecasts are only as good as your bookkeeping reports and financial data. For example, If you haven’t updated your books in 6 months, then your ability to create forecast models will be limited.  
  • Analysis paralysis: Cash flow forecasting can give business owners more information than they can process at one time. Instead of using this data to make business decisions, they get overwhelmed and do nothing with it. 

    This is why it can be helpful to work with an advisor or bookkeeper you trust and has a great understanding of the nuances of your business.  

Improve the accuracy of your cash flow forecasts  

Ultimately, the biggest challenge is that cash flow forecasts are essentially predictions. You are betting on what your business will be like in the future based on historical data. This means that having accurate, historical financial data is critical.  

Cash flow forecasting should be an active document that gets updated regularly. It should be used as a tool for business owners and senior leaders in your organization to use to help predict cash flow and reduce the risk of running out of funds. 

improve the accuracy of your cash flow forecast

Update for your actuals

At week or month end, its critically important to enter your actual results (the cash that was received and cash that left your bank accounts). Entering your actual cash flows for the month just passed, you will see what items you got wrong in your predictions. Assess WHY you got this wrong, it could be more sales (great!) but also could speak to a bigger issue about your assumptions for the future. This analysis will allow you to spot any issues quickly, and make adjustments before they become big problems. 

At your meeting to update the cash flow, first spend 25% of your time assessing your predictions VS actuals, and the remaining 75% of time considering how this looks for the next 12 months..  

Here are some additional tips to help you improve the accuracy of your cash flow forecasts: 

  • Constantly evaluate all of your assumptions, especially when it comes to sales. Just because an assumption is correct now doesn’t mean it will be in the future. For every line item, go through and validate it. 
  • Include any annual payments, estimated taxes, loan payments, and credit card debt payments. 
  • Don’t rely on a forecast any longer than one year out. It is nearly impossible to predict the nuances of your business three years from now. The further out your models go, the more risks and uncertainty you’ll introduce. 

Avoid these 4 cash flow forecasting mistakes 

Here are some of the frequently made mistakes to be wary of when managing cash flow for your business.

1. Assume their business will continue to grow and go up and to the right each month 

Naturally, people don’t want to predict sales declines or negative growth. However, being overly optimistic or aggressive about your assumptions of sales can be a catastrophic mistake. You need to be honest with yourself about future projections and account for scenarios where sales may decline.

One strategy to counter overly optimistic forecast models is to get better at analyzing existing trends in your business.

For example, if you are an eCommerce business that typically does 75% of your annual revenue in Q4 and last year sales were down 10%, you’ll want to adjust your forecasts to this new reality. 

3. Making business decisions based on incomplete financial data  

If you don’t update your projections whenever something happens in your business to affect cash flow, then you won’t be working off of accurate numbers. Reduce the risk of this mistake by staying on top of your bookkeeping on a regular basis (ideally weekly). 

4. Lack of communication among key stakeholders 

When all relevant financial advisors and team members aren’t in the loop, it’s easy to miss important pieces of information that might affect the business in the year ahead. Develop communication channels, such as a weekly or monthly meeting, to keep everyone informed and aligned. 

Whether you’re cutting expenses in survival mode, or predicting your sales in growth mode, it’s important to have a clear picture of the cash in your bank account. Remember, cash is king. Business owners that have a handle on their cash flow are in a better position to make important decisions for the future health of their business.  

Revenue is vanity, profit is sanity, and cash is reality.

Want to learn more about actionable cash flow management and cash flow forecasting strategies? Check out this video below.

And, If you need help creating a cash flow forecast for your business, we can help. Simply book a discovery call with a Financial Coach to chat through your current challenges and work out a plan to get you on the right path!

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Tom Mercer

Tom Mercer

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