What is a Cash Flow Forecast?

Imagine the following scenario: a large bill comes in for some office repairs you’ve had done for your company, with Net 30 terms. You pay it, but then realize you don’t have enough money left to pay your employee in two weeks! You scramble to collect on your accounts receivable so your employee can be paid on time. If you want to prevent this type of scenario, a great way to do it is to regularly take a look at your cash flow forecast, particularly if money is tight.

1. What is a Cash Flow Forecast?
2. Why Use It?
3. What Should be Included?
4. Methods of Cash Flow Forecasting
5. How to keep an Accurate Cash Flow Forecast

A cash flow forecast will give you an overview of inflows and outflows of cash in your business, so you can prioritize who to pay when. In the above scenario, a cash flow forecast could have helped show that there isn’t enough cash for both at one time, so the employee’s paycheque should be prioritized.

What is a Cash Flow Forecast?

A cash flow forecast generates a report, mostly from accounts receivable, accounts payable, and payroll, that shows how much money your business will have at any given time. Short-term cash flow forecasts are generated from actual data already on your accounting books: anticipated transactions for accounts receivable, accounts payable, and payroll over the next 30 days can usually be generated without having to make estimates. Longer-term cash flow forecasting relies on projected data based on estimates of sales, wages, bills, and other income and expenses for up to a year.

Why Use a Cash Flow Forecast?

Cash flow forecasting helps you maintain the liquidity of your business. As mentioned above, cash flow forecasting is useful in helping you make the best decisions about when to pay wages, bills, and other payables based on how much cash you’ll have available to do it. Cash flow forecasting can also help you decide when you’ll be able to afford to buy new equipment or software without jeopardizing your ability to pay important bills.

In the longer term, cash flow forecasts can help you spot potentially chronic liquidity problems in the future, so that you can take action to fix them before they begin to affect your relationships with employees and suppliers. For example, you might notice that your project to regularly have more cash going out than coming in over the next six months, and decide that another loan is necessary until you’re able to increase sales. If you are thinking about finding investors, cash flow forecasting is essential to show that your business is being managed properly.

What Should be Included in a Cash Flow Forecast

A cash flow forecast should include cash inflows, such as money from loans, interest, sales, and sales of assets, as well as cash outflows, such as wages, payments on loans, and bills, and the opening cash balance for the starting month. To create a simple cash flow forecast template, list cash inflows and outflows based on anticipated future transactions to generate a net cash flow figure, then list the opening and closing balance for the period in question.

In the example below, January’s opening balance was 4,500, and the closing balance was the opening balance plus the net cash flow for the month, so it’s easy to see what cash was started and ended with for the period. The opening balance of the next period (in this example, February), is generated from the closing balance of the previous month.

In this example, we can see that money will be tight in March, but that selling a fixed asset (a desk, perhaps) will help the net cash flow for the month remain positive.

Methods of Cash Flow Forecasting

Broadly speaking, there are two methods of cash flow forecasting: direct and indirect.

The direct method is for short-term forecasting and is based on direct cash transactions anticipated in the near future, based on what is currently in your accounting books. This method may still require some estimating in point of sale businesses such as retail; other businesses that invoice can use existing invoices to predict cash flow in.

The indirect method projects data over a series of months to predict what your cash flow will look like over the longer term. This requires estimates of your income, expenses, and other cash inflows and outflows. If you’ve been in business for a while, you can use prior income statements to predict future income – however, if you are new to business and don’t have enough data for an estimate, you can always calculate your estimated expenses first and use the estimate to generate an estimate of the income you’ll need to bring in to cover them.

How to keep an Accurate Cash Flow Forecast

The best way to keep your cash flow forecasts accurate is to keep doing them, and compare them to your cash flow statements. There are will always be things you won’t see coming, but you may be able to identify trends in the discrepancies between what you predicted and what actually happened. Say, for example, that your cash flow forecasts predict that you’ll receive payment from your clients within 30 days, when your cash flow statements indicate that you don’t have the cash you expected you would within that time frame. While you can try to get on top of collections to mitigate this, you can also factor it into your next cash flow forecast so you can be financially prepared for the delay in payments.

Getting better at predicting your cash flow will help you keep on top of things, whether that means taking out a loan, selling more inventory, or saving money for operating costs during times that you know when the business will slow down. Cash flow forecasts are a great way to make sure that your business relationships don’t suffer as a result of a lack of attention to money management.