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How to Forecast Cash Flow

December 26, 2018
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Businesses talk a lot about budgets, revenue projections, and actuals. However, one of the most important planning tools that a business of any size must do is forecast cash flow.

Cash flow forecasting is critical for a healthy business. Even profitable businesses can be hurt if they don’t have the cash flow to support day to day operations. That’s why businesses need to know how to forecast cash flow as much as any other planning you do.

What Cash Flow Forecasting is – and What it isn’t

Cash flow forecasting is building a plan to ensure that you have the liquid assets you need to maintain business operations. It’s the cash and liquid assets available to you to pay your bills, plus your estimated inflows and outflows.It isn’t your revenue. While revenue is also an important number to understand for the health of your business, it doesn’t represent cash that you can use to pay bills like rent, inventory, and salaries. Revenue is what your company has earned on the sale of your goods or services, but depending on how and when your clients pay, may not be immediately available to you to keep the lights on. cash flow is both what is coming in and what is going out.There are two methods of forecasting cash flow – the indirect method and the direct method. The indirect method tends to give you a longer view of your cash flow and is used for capital projects and longer-term growth. The projections are pulled from the profit and loss and balance sheets and balance sheet items, like purchases or depreciation, are added or subtracted.

The direct method, however, is better for shorter to medium term forecasting. It takes the known operating inflows and outflows and uses these actuals to create the forecast. It makes short-term predictions highly accurate but requires a lot more guesswork for longer term forecasts.

Important Elements of Cash Flow Forecasting

Regardless of which method you use, you’ll still need to know some elemental pieces of information to produce a useful forecast.

How much cash will be coming in?

Obviously, to forecast your cash flow, you’ll need to understand first how much cash you’ll be bringing into the business. The best place to turn for this information is the past. Your past sales performance should be an excellent source of knowledge on the topic. It will tell you not only volume, but trends, ebbs, and flows.If you’re using spreadsheets, it might be more difficult to extract complete, accurate data that shows these trends and changes over time. Cash flow forecasting software that can easily produce reporting on historical numbers can simplify this step, and all the steps, of the forecasting process.

What are your clients’ payment terms?

Even when you make a sale, the cash is not immediately available to you for use in running your business. Even for the smallest business, there is a delay between purchasing the materials to make a product or pay salaries and realizing the cash from the sale.For many companies, clients pay thirty or more days after a sale. Even if your sales history shows a big month in March, you may not realize the funds from those sales until April, or later. It’s critical to a positive cash position that you take into account payment terms when forecasting your cash flow.Be sure to also review your collections frequency. If ten percent of your sales are paid late, you should account for that in your forecast, as well. Again, clear historical reporting can make this step easier and much more accurate.

What are you spending money on, and when?

Knowing what your company spends is the last piece of the cash flow forecast puzzle. Some of your spend is predictable, some is fixed, and as much of it as possible needs to be accounted for in your projections.Fixed spends are generally easy to gather and fit well into your forecast. These are things like rent, software licenses, and salaries. Predictable, but perhaps not fixed, expenses are things like utilities, property taxes, and regular equipment purchases, like when a new employee is hired. Variable expenses include repairs for broken equipment, changes in costs for sales and marketing needs, and fluctuations in inventory and supplies.The fixed and predictable expenses are fairly straightforward to add to your forecast, whereas, again, your historical expenditures should help to formulate predictions on irregular expenses.Without cash to handle expenses, a business would flounder and die. Understanding your business’s cash flow needs, and staying on top of them, will help keep your operations and your overall organization running along smoothly. The more accurate your reporting from previous years is, the better your cash flow projections will be in the coming year. Revisit your cash flow forecast frequently to keep your business running smoothly.

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