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14.6.2019 | Last updated: 17.7.2024

13 min read

What is cash flow forecasting and why you should do it?

All companies, despite the size or the business area, should be doing cash flow forecasting. It is an effective way to accurately project future liquidity positions based on short- and mid-term payment obligations and expected incoming cash flows.  In this article we will answer common cash flow forecasting questions like: what is cash flow forecasting, why is cash flow forecasting important and how cash flow forecasting benefits companies?

Understanding cash flow forecasting

What is cash flow?

Cash flow refers to the movement of money into and out of a business, reflecting its liquidity and ability to meet short-term obligations. Unlike profit, which is the surplus after all expenses are deducted from revenue, cash flow focuses on actual cash transactions, including non-revenue activities like loan payments and investments. Thus, a business can be profitable on paper but still face cash flow problems if it doesn't manage its incoming and outgoing cash effectively.

What is a cash flow forecast?

Cash flow forecasting is a critical financial management tool that estimates the inflow and outflow of cash within a business over a specific period, enabling more precise budgeting and financial planning. A cash flow forecast consolidates the information of expected future cash inflows and outflows of a company’s bank accounts over a given period, indicating whether there is sufficient liquidity to run the business and providing an opportunity to better plan future actions. This process involves analyzing historical financial data, current market conditions, and projected business activities to predict future cash flows accurately. It also helps businesses optimize the amount of cash in their bank accounts, preventing both excessive idle cash and cash shortages. By identifying potential liquidity issues in advance, businesses can implement strategies to mitigate financial risks, ensuring they have sufficient cash to meet their obligations, ultimately supporting better financial stability, sustainability, strategic growth, and operational efficiency.

Types of cash flow forecasting

There are three primary types of cash flow forecasts: short-term cash flow forecasts, mid-term and long-term cash flow forecasts:

Short-term cash flow forecasts typically cover a period ranging from one week to three months, focusing on immediate cash needs and day-to-day operations. These forecasts are crucial for managing working capital, ensuring the company can meet its short-term liabilities, like payroll, supplier payments, and other operational expenses.

Medium-term cash flow forecasting typically covers a period ranging from three months to one year. It serves as a bridge between short-term operational needs and long-term strategic planning, helping businesses anticipate cash fluctuations and plan for medium-range financial commitments and investments. This forecasting period is crucial for managing seasonal variations, capital expenditures, and adapting to changing market conditions while maintaining financial stability.

On the other hand, long-term cash flow forecasts extend beyond three months and can cover periods up to a year or more. They are used for strategic planning, investment decisions, and assessing the company’s financial health over a more extended horizon. Long-term forecasts help businesses prepare for significant expenditures, potential funding requirements, and overall financial sustainability, aligning with broader business objectives and growth strategies.

Why is cash forecasting important?

Cash forecasting is valuable for companies of all sizes, local small businesses as well as large multinational corporations. First, it is a way to make sure your business never runs out of cash unexpectedly and can deal with its payment obligations. It is also an excellent way to optimize the amount of working capital, to have enough to run the business but no cash laying on accounts purposelessly. Cash flow forecasting can be and should be done on the short term as well as long term. Being able to present a reliable cash flow forecast can also be valuable when negotiating external funding.

The importance of cash flow forecasting

Cash flow forecasting ensures liquidity

Liquidity refers to the company's ability to quickly convert its assets into cash to meet short-term obligations and operating expenses. High liquidity indicates that a company can easily pay its debts and continue operations smoothly, while low liquidity suggests potential difficulties in covering immediate financial needs.

Cash forecasting helps businesses to maintain liquidity by predicting future cash inflows and outflows, allowing businesses to plan and ensure they have enough cash to meet their obligations. By anticipating potential cash shortfalls or surpluses, companies can make informed decisions about borrowing, investing, or cutting expenses. This proactive approach minimizes the risk of liquidity crises, ensuring the business can operate smoothly and avoid financial distress.

Cash flow aids in financial planning and decision making

Cash flow forecasting can play a crucial role in budgeting and financial planning by estimating future cash positions, allowing businesses to allocate resources effectively and plan for contingencies. It helps ensure that sufficient funds are available for operational needs, investments, and debt obligations, thereby supporting overall financial stability.

A few example scenarios where forecasting aids decision making:

  1. Expansion decisions: Predicting cash flow helps to determine if there are sufficient funds to support the opening of a new branch or investing in new equipment.
  2. Managing seasonality: Businesses with seasonal cash flow variations can plan for periods of low revenue by ensuring adequate cash reserves are available during off-peak times.
  3. Debt management: Forecasting helps in planning the repayment schedule of loans without straining operational cash flow, avoiding potential liquidity issues.
Cash flow forecasting helps in identifying potential cash shortfalls

Cash flow forecasting can have a critical role in identifying cash flow gaps by projecting future inflows and outflows of cash. By comparing expected cash receipts and payments over a specified period, businesses can pinpoint times when cash outflows might exceed inflows, potentially causing liquidity issues. This proactive approach allows businesses to anticipate and address cash flow gaps by adjusting spending, timing payments, or securing additional financing before they become critical, ensuring smoother financial operations.

Early detection of financial issues is crucial because it allows businesses to take timely corrective actions before problems escalate. By identifying issues such as cash flow shortages, declining profitability, or excessive debt early on, businesses can implement strategies to improve financial health, such as cost-cutting measures, renegotiating terms with creditors, or adjusting pricing strategies. This proactive approach helps mitigate risks, preserves financial stability, and ensures the business remains resilient in challenging economic conditions.

Cash flow forecasting helps to control currency risks

Cash flow forecasting helps control currency risks by predicting future cash inflows and outflows in different currencies, enabling businesses to hedge against exchange rate fluctuations. By accurately forecasting cash flows in various currencies, companies can make informed decisions about when to convert currencies, reducing the impact of unfavorable exchange rate movements on cash positions. This proactive management helps to stabilize cash flows and protect profitability from currency volatility.

Cash flow forecasting facilitates investor relations

Cash flow forecasting facilitates investor relations by providing transparency and predictability regarding a company's financial health and liquidity. Investors use cash flow forecasts to assess a company's ability to generate cash and meet financial obligations, which influences their confidence and investment decisions. Clear and accurate cash flow projections help build trust with investors, demonstrating proactive financial management and enhancing the company's credibility in the market.

Components of cash flow forecast

Opening balance

The opening balance is crucial for cash flow forecasting because it represents the starting point of available cash at the beginning of the forecast period. It provides context for understanding the initial financial position of the business, influencing projections of future cash inflows and outflows. By accurately accounting for the opening balance, businesses can ensure the forecast reflects the actual cash on hand, enabling better planning and management of cash flow throughout the forecast period. This helps in avoiding inaccuracies in projections and ensures that financial decisions are based on a solid foundation of current cash availability.

Cash inflows

Cash inflows like sales revenue and other income sources like investments and loans are crucial for cash flow forecasting as they directly impact a company's liquidity and financial stability. In many situations, sales revenue forecasts provide the primary source of operating cash flow, helping businesses plan for expenses and investments. Additionally, income from investments and loans can supplement cash reserves, providing flexibility during periods of fluctuating revenue or unexpected expenses. Accurately forecasting these inflows allows businesses to manage cash effectively, maintain liquidity, and make informed strategic decisions to support growth and financial sustainability.

Cash outflows

Cash outflows such as operating expenses, capital expenditures, and debt repayments are essential for cash flow forecasting because they represent the primary uses of cash within a business. Understanding and forecasting these outflows allow businesses to plan for necessary expenditures, manage cash flow effectively, and ensure sufficient liquidity to meet financial obligations. By accurately predicting operating expenses, capital investments, and debt repayments, businesses can avoid cash shortages, maintain financial stability, and make informed decisions regarding budgeting, financing, and resource allocation.

Net cash flow

Calculating net cash flow is crucial for cash flow forecasting as it provides a clear picture of the overall cash position after accounting for both cash inflows and outflows. It helps businesses understand whether they will have surplus cash (positive net cash flow) or face deficits (negative net cash flow) over a specific period. This information is vital for planning and decision-making, enabling businesses to anticipate cash needs, manage liquidity effectively, and make strategic adjustments to operations, investments, and financing.

The importance of positive cash flow lies in its indication of financial health and sustainability. A positive cash flow means that a business is generating more cash than it is spending within a given period. This surplus cash can be used to reinvest in the business, repay debts, fund growth initiatives, or build reserves for future uncertainties. Positive cash flow is essential for maintaining liquidity, meeting financial obligations on time, and demonstrating financial strength to stakeholders, including investors, creditors, and suppliers. It also provides a buffer against economic downturns or unexpected expenses, enhancing overall stability 

How to create a cash flow forecast

Creating a reliable cash flow forecast is crucial for financial planning and stability. Follow these structured steps to develop an effective forecast:

1. Gather financial data

  • Collect historical financial data to understand past trends and patterns.
  • Project future sales and expenses based on market analysis and business plans.

2. Estimate cash Inflows

  • Utilize methods such as market research and sales projections to forecast future sales accurately.
  • Consider additional income sources like investments or grants to complete the picture.

3. Estimate cash outflows

  • Predict regular operating expenses such as payroll, rent, and utilities based on historical data and current obligations.
  • Plan for irregular expenses like equipment upgrades or marketing campaigns that may impact cash flow.

4. Prepare the forecast

  • Utilize cash flow forecast templates or specialized software to structure your financial projections systematically.
  • Ensure the forecast is comprehensive, detailing both inflows and outflows over the forecast period.

5. Review and adjust

  • Regularly review the cash flow forecast to monitor actual performance against projections.
  • Adjust forecasts based on emerging trends, actual financial outcomes, and changes in business conditions.

By following these steps, businesses can enhance their financial management capabilities and make informed decisions to navigate potential cash flow challenges effectively.

Tools and software for cash flow forecasting

Spreadsheet tools

While common and widely available, using spreadsheet tools like Excel or Google Sheets for cash flow forecasting offers several advantages and disadvantages:

Pros of using spreadsheet tools for forecasting
  • Flexibility: Spreadsheets allow for customizable cash flow templates, accommodating specific business needs and complexities.
  • Accessibility: Tools like Excel and Google Sheets are widely accessible and user-friendly, making it easy for finance professionals to input data, manipulate formulas, and generate forecasts.
  • Integration: They can integrate with other financial data and accounting software, facilitating seamless data import and updates.
Cons of using spreadsheet tools for forecasting

Manual Input: Spreadsheets rely heavily on manual data entry, which can be time-consuming and prone to human error.

Version Control: Managing multiple versions of spreadsheets can lead to confusion, especially when multiple users are involved.

Limited Scalability: For large datasets or complex forecasting models, spreadsheets may become slow, cumbersome, or difficult to maintain.

In practice, while spreadsheets are effective for initial cash flow forecasting, businesses often complement them with specialized financial software or cloud-based solutions for enhanced automation, collaboration, and scalability.

Dedicated cash flow forecasting software

Dedicated cash flow forecasting software offers a range of features and benefits tailored specifically to the task of predicting and managing cash flows. Here are some key features and their associated benefits:

Features of Dedicated Cash Flow Forecasting Software:

  1. Automated data integration:

    • Feature: Integration with accounting systems and financial data sources to automate data import.
    • Benefits: Reduces manual data entry errors, saves time on data collection, and ensures accuracy in forecasts by using real-time data.
  2. Scenario analysis:

    • Feature: Ability to create multiple scenarios based on different assumptions (e.g., sales growth, cost reductions, economic changes).
    • Benefits: Helps businesses evaluate the impact of various scenarios on cash flow, enabling better decision-making and strategic planning.
  3. Cash flow visualization:

    • Feature: Graphical representation of cash flow forecasts, including charts, graphs, and dashboards.
    • Benefits: Enhances visibility and understanding of cash flow trends, facilitates communication with stakeholders, and aids in identifying patterns and anomalies.
  4. Forecast accuracy:

    • Feature: Utilization of advanced algorithms and forecasting models (e.g., predictive analytics, machine learning).
    • Benefits: Improves the accuracy of cash flow predictions by considering historical trends, seasonality, and external factors, helping businesses make more reliable financial decisions.
  5. Collaboration and reporting:

    • Feature: Collaboration tools for multiple users to input data, review forecasts, and share reports.
    • Benefits: Promotes teamwork and transparency, ensures everyone is working with up-to-date information, and facilitates streamlined reporting to stakeholders.
  6. Cash management tools:

    • Feature: Tools for managing cash inflows and outflows, including monitoring receivables, payables, and liquidity.
    • Benefits: Optimizes cash flow by identifying opportunities to accelerate receivables, delay payables, or use surplus funds effectively, thereby improving overall financial health.
  7. What-if Analysis:

    • Feature: Capability to perform what-if analysis to simulate the impact of potential decisions on cash flow.
    • Benefits: Enables proactive planning and risk management, allowing businesses to assess the consequences of strategic initiatives or unexpected events before implementation.
  8. Alerts and Notifications:

    • Feature: Automated alerts and notifications for critical cash flow thresholds or deviations from forecasted values.
    • Benefits: Helps businesses stay informed in real-time, allowing prompt action to address cash flow issues or capitalize on opportunities as they arise.

Benefits of using dedicated cash flow forecasting software:

  • Improved accuracy: By leveraging automation and advanced forecasting techniques, dedicated software enhances the accuracy of cash flow predictions compared to manual methods or generic tools.

  • Time savings: Automating data integration and calculations reduces the time spent on manual tasks, allowing finance teams to focus more on analysis and strategic planning.

  • Decision support: Provides actionable insights and scenario analysis that empower decision-makers to make informed choices regarding investments, cost management, and financial strategies.

  • Enhanced visibility and transparency: Visualization tools and collaborative features promote transparency across departments, ensuring everyone has access to consistent, up-to-date financial information.

  • Risk management: Enables proactive identification and mitigation of cash flow risks, helping businesses anticipate and navigate financial challenges effectively.

  • Scalability: Designed to handle large datasets and complex forecasting models, dedicated software scales with the growing needs of businesses without compromising performance.

In summary, dedicated cash flow forecasting software offers comprehensive features and benefits that not only streamline the forecasting process but also empower businesses to manage cash flow more effectively, mitigate risks, and drive sustainable growth.

Automation and predictive analytics

Predictive analytics and automation provide significant benefits in cash flow forecasting by leveraging data-driven insights and reducing manual effort. Here are the key advantages:

  • Improved accuracy: Predictive analytics use historical data, patterns, and statistical models to forecast future cash flows more accurately. By identifying trends and correlations that may not be apparent through traditional methods, predictive analytics enhance the precision of forecasts.
  • Real-time insights: Automation allows for the continuous monitoring and updating of cash flow data, providing real-time insights into financial performance. This capability enables businesses to react swiftly to changes in cash flow dynamics, such as unexpected revenue fluctuations or sudden expense increases.
  • Efficiency and time savings: Automation reduces the manual effort involved in data collection, calculation, and reporting. It streamlines the entire cash flow forecasting process, allowing finance teams to focus on analysis and strategic decision-making rather than administrative tasks.
  • Scenario analysis: Predictive analytics facilitate what-if scenarios by simulating the impact of different variables (e.g., sales growth, economic changes) on cash flow. This capability helps businesses assess the potential outcomes of various decisions or external factors, enabling more informed and proactive planning.
  • Risk management: By identifying potential cash flow gaps or surpluses early on, predictive analytics aid in proactive risk management. Businesses can anticipate liquidity needs, plan for contingencies, and mitigate financial risks effectively, reducing the likelihood of cash flow crises.
  • Strategic insights: Predictive analytics provide deeper insights into the underlying drivers of cash flow trends. This knowledge helps businesses identify opportunities for operational improvements, cost efficiencies, and revenue optimization, thereby supporting long-term strategic goals.
  • Compliance and reporting: Automated processes ensure consistency and accuracy in compliance reporting and financial statements. This capability is particularly beneficial for regulatory requirements and investor relations, enhancing transparency and credibility.

In summary, dedicated cash flow forecasting software offers comprehensive features and benefits that not only streamline the forecasting process but also empower businesses to manage cash flow more effectively, mitigate risks, and drive sustainable growth.

How can a cash flow forecast help a business like yours?



1. You will get a better view of your company’s liquidity and where it is.
2. With the information, you can optimally plan your cash distribution.
3. You will be prepared for cash shortages.
4. You can control currency risks.
5. You will get data that helps you to make better decisions.
6. It can also help you to spot harmful patterns, such as late-paying customers or partners, or delays in processing purchase invoices.

5 steps to start cash forecasting

 

  1. Identify the systems or processes that contain information of future incoming cash flows; the AR ledger, order book, recurring subscriptions, etc. When extracting information from the order book, remember to keep the focus on the timing of the expected cash flows.
  2. Identify the systems or processes that contain information on future outflows; the AP ledger, purchase invoice processing solution, purchasing system, leasing agreements, and so on. Again, focus on the timing of the cash flows.
  3. Collect the information about bank account balances and actual cash flows.
  4. Maintain a continuous consolidation of the above data, in order to establish a timely calculation of the expected development of your liquidity.
  5. Evaluate the forecast against realized cash flows. How accurate was it? Improving your data based on the feedback from previous forecasts will lead to high-quality forecasts, which will make cash management much easier.

 

If you are thinking of preparing cash flow forecasts in Excel, think again. There are several sophisticated software solutions available, and most of them are cloud-based, which makes implementation and use carefree. A niche solution offers a high level of automation to your cash forecasting process to reduce manual work and the risk of human errors. A correctly chosen tool supports the continuous improvement of the forecast quality by providing variance analysis and accuracy feedback to all involved users.

Hopefully, this post will encourage you to start tackling the cash flow forecasting challenge. With the help of suitable tools, you will get continuous visibility into your data – and after a short learning period, you will also learn how to use that data to get all the potential out of cash forecasting.