You need to know how much cash is coming into the business.
But modeling that out can be a challenge.
That's why we wrote this guide to cash flow forecasting.
Let's get started.
Updated: July 14, 2023 |
By
Jake Ballinger is an experienced SEO and content manager with deep expertise in FP&A and finance topics. He speaks 9 languages and lives in NYC.
You need to know how much cash is coming into the business.
But modeling that out can be a challenge.
That's why we wrote this guide to cash flow forecasting.
Let's get started.
FP&A Writer, Cube Software
Sign up for our bi-weekly newsletter from serial CFO and CEO of Cube, Christina Ross.
Cash flow forecasting is a short to medium-term estimate of how much money comes in and out of a business. It looks at operations, financing, and investment on a detailed level to give an overall sense of a company’s financial health.
It’s one of the most important parts of a business plan for one reason: every company could run out of cash without proper short-term planning. That’s why it’s part of the holy trinity of financial documents alongside the income statement and balance sheet statement.
Say you get into your car and type into your GPS system where you want to go. It gives you the best route based on current traffic conditions, updates the route if there’s an accident, and even plots out the best journey to save on gas. But the further away that journey is, the less likely it is that the current best route will be accurate.
Cash flow forecasting does the same for your business. It helps you chart a short-term financial course based on key factors like expected revenue and expenses. This way, you can navigate any potential financial roadblocks on the way and predict how much cash you’ll have on hand. And like the car GPS, the further out you try to predict, the less accurate it’s likely to be.
Every business needs to understand how much cash they’ve got in the bank at any given point. Profits and revenue are nice, but they’re high-level figures that don’t reflect what’s happening at the ground level.
A company can spend money on things like new equipment, which doesn’t reduce profitability, but it does reduce the bank account balance. It’s the same with cash coming in, too - a customer might be late with a payment, so the cash isn’t in the bank accounts yet, but the top-line figure shows the revenue generated.
That’s why it’s vital to have cash flow forecasting sorted: every other financial metric might look great, but there needs to be a sense of how much money is coming in and out to pay staff, office rent, and buy inventory.
Still not convinced?
Here are other reasons why having a cash flow forecast in place can keep you on track financially and save you from any unexpected headaches.
Reason dictates the more you know about the financials of your business, the better you can make an effective decision on the following steps to take for your business. If there’s a surplus of cash, it could be put to better use and invested back into the business, whereas a shortage means something needs to change in the near future.
Say you want to hire employees for seasonal work or want to cut back on expenses for a few months to shore up the bank balance - an accurate cash flow forecast lets you work out what you need to do to achieve that goal.
A cash flow forecast helps you expect the unexpected. By that, we’re talking about those supply chain disruptions, the loss of a major client, and economic downturns nobody can predict. Knowing if there’s enough cash and for how long can go a long way in reassuring investors and employees when times get tough.
Cash flow forecasts are one part of the bigger picture. They can feed into longer-term financial planning to help discover trends in the data and adjust strategies that might not be working to their fullest potential. For instance, a cash flow forecast’s short-term view of liquidity and working capital can keep long-term financial projections and goals on track.
The more financial data coming in, the more complete the puzzle is - and you’ll have confidence in the options available if you need to change course.
A cash flow forecast is a handy source of information to see if money could run out in the given timeframe. This can give you time to prepare for a line of credit or loan or consider raising funding well before the situation gets desperate.
Anyone putting money into a business wants the complete financial picture possible to see if there will be a return on their capital. A cash flow forecast can help to reassure investors and other key stakeholders that all is well with the company and that the money is being handled well over the next few months.
This level of transparency can help to build trust with potential investors too. If stakeholders can see that a business is committed to its financial health and has a positive cash flow, it’ll make those tricky meetings a little easier.
The cash flow forecasting process concerns three areas: projected income, projected expenses, and cash balances.
Let’s get into the details of why these are so important in cash flow forecasts.
Also known as cash inflows, this is the money the company expects to bring in during a set period. Many different types of income fall under this category: some common examples are cash sales, accounts receivable, and tax refunds.
This is money coming out of the business in the timeframe, also known as cash outflows. Some typical expenses include COGS, accounts payable, loan payments, and office rent.
It’s the cash money, honey. The liquidity that’s sat in the bank account. Each cash flow projection starts with the opening cash balance at the start of the timeframe. The net cash flow is the total projected income minus the total projected expenses; it determines whether a business has a positive or negative cash flow.
Then comes the closing cash balance, which is how much money the company will have in the bank by the end of the period.
So, how does one go about putting together a cash flow forecast? There are two commonly used methods: direct and indirect techniques. Each has its own uses and disadvantages. Let’s get into them.
This method looks at the actual cash payments coming in and out of the business. This includes things like customer payments, supplier payments, employee salaries, and anything else that counts as an individual cash payment.
Because it’s a more granular view of a company’s financial health, it works well for short-term forecasting cash flow and spotting any issues on the immediate horizon.
You can’t deny that accountants love this method. It’s because the direct method is a far more detailed process that dives into the nitty gritty of a company’s cash flow. Investors are fans of this model, too, as they can make more informed decisions on whether a company is running a positive cash flow or has something to hide.
But there’s a big drawback: the time it takes to put a direct forecast cash flow together can be prohibitive for some businesses. You have the double-edged sword of any late payments or outgoings not painting a true financial picture and the time input for such a granular view of a company’s transactions. That’s why it’s recommended for companies with more dependable future cash flows.
Here’s a step-by-step breakdown of how to accurately calculate cash flow statements using the direct method.
Here’s an example of the direct method in action for a medium-sized business:
Item | Month 1 | Month 2 | Month 3 |
Opening cash balance | $10,000 | $12,500 | $14,000 |
Cash inflows | |||
Sales revenue | $15,000 | $18,000 | $20,000 |
AR collections | $5,000 | $6,000 | $7,000 |
Loan proceeds | $0 | $10,000 | $0 |
Total cash inflows | $20,000 | $34,000 | $27,000 |
Cash outflows | |||
Inventory purchases | $5000 | $7000 | $8000 |
Rent | $2000 | $2000 | $2000 |
Payroll | $6000 | $6500 | $6500 |
Utilities | $1000 | $1000 | $1000 |
Marketing | $1500 | $2000 | $2500 |
Loan repayments | $2000 | $1000 | $1000 |
Total cash outflows | $17,500 | $19,500 | $21,000 |
Net cash flow | $2500 | $14,500 | $6000 |
Closing cash balance | $12,500 | $27,000 | $20,000 |
The opening cash balance is $10,000, with estimated monthly inflows and outflows. For each month, the total cash outflow is subtracted from the total cash inflow to reach the final net cash flow figure. Each closing balance then becomes the opening balance for the following month. Simple!
This method starts with the net income figure and working out the asset and liability adjustments. It works on accrual rather than cash like the direct method, so it reports income when it was earned rather than received.
The indirect method is much easier for companies to put together because it’s more top-level than the direct method of going through each cash transaction line by line. That’s why it works better for bigger companies with many different incomings and outgoings. It’s also quicker to forecast because some payments and outgoings can take time to flow in or out of the account.
The main drawback of the indirect method is that it doesn’t give the same level of detail as the direct method. Without the more detailed breakdowns and visibility, anyone looking in from the outside might not fully understand the company’s financial picture.
Let’s look at calculating accurate cash forecasting using the indirect method. Get ready for a step-by-step process.
Stuck on how this would work in real life? Here’s an idea of how the indirect cash flow method would work for a business.
Item | Month 1 | Month 2 | Month 3 |
Net income | $8000 | $9000 | $10,000 |
Adjustments for non-cash items | |||
Depreciation | $1500 | $1500 | $1500 |
Stock-based compensation | -$200 | -$200 | -$200 |
Subtotal: Non-cash items | $1300 | $1300 | $1300 |
Adjustments for changes in working capital | |||
Decrease in accounts receivable | $500 | $600 | $700 |
Increase in inventory | -$1000 | -$1500 | -$2000 |
Increase in accounts payable | $800 | $1000 | $1200 |
Subtotal: changes in working capital | $300 | $100 | -$100 |
Operating cash flow | $9600 | $10,400 | $11,200 |
Net cash flow | $9600 | $10,400 | $11,200 |
Opening cash balance | $10,000 | $19,600 | $30,000 |
Closing cash balance | $19,600 | $30,000 | $41,200 |
The indirect cash flow forecast zones in on operating cash flow by adjusting the net income for non-cash items and any changes in working capital. In this instance, the net cash flow is the same amount as the operating cash flow.
Now you know all about cash flow forecasting.
But did you know that Cube can help you with cash flow management and financial modeling?
For example, getting your actuals and historicals into Excel can be a pain.
As can keeping track of the myriad versions of that model.
Cube solves those problems.
It connects to your source systems, enforces data integrity, and natively integrates into Excel and Google Sheets.
So collaboration with members of the team or department leaders has never been easier.
Sound interesting?
Click the image below to request a free demo.