Poor cash flow forecasting is a major reason businesses fail. There are a lot of challenges to come up with an accurate cash flow forecast, but it needn't be perfect to provide you with important information. In this post, we'll explain what cash flow forecasting is, and go over some best practices for performing your cash flow forecasting.
Cash flow forecasting is the process of predicting what the financial situation of your company will be in the future. It relies on counting up all your expected income and expenses and using that to determine your cash position and make cash flow projections. Cash flow forecasts help businesses manage liquidity and predict whether they'll have enough cash on hand to meet financial obligations.
So how exactly does an accurate cash flow forecast help a business manage liquidity? And what types of decisions does it empower business owners to make? Let's look at three ways a cash flow forecast brings value to your business operations.
If you're convinced of the value of cash flow forecasts, then the next step is to create one for your business. In order to do that, you'll need to know the sorts of things that go into a cash flow forecast. The list below may not be complete, as it varies depending on your business. So be sure to adjust the inputs for the income statement to match your situation.
In order for a cash flow forecast to be accurate, it needs to take every source of incoming cash into the account. It's very easy for a business to look at revenue and neglect other, less visible, forms of incoming cash. Let's take a look at some common items that count towards cash inflow.
Similarly to cash inflows, it's easy to look at the common sources of cash outflow, but ignore the less visible ones. Again, every business will differ, but here are the common things to look for:
Now that you have an idea of the types of variables that go into a cash flow forecast, let's talk more specifically about the forecasting method itself. There are actually two methods that can be used for cash flow forecasting: direct and indirect. Understanding the difference will help you decide which is right for your business.
The direct method is less commonly used, but much easier to calculate. The direct cash flow forecasting formula is exactly what you would expect: cash flow = receivables - expenditures. As you can see, this method directly uses cash inflow and outflow to generate its output. The reason this method isn't very common is that it can become cumbersome to gather the data, especially for companies that use accrual-basis rather than cash-basis accounting.
The indirect method for conducting cash flow forecasting starts with net income and then accounts for items that affect profit but not cash flow. In accrual-basis accounting, transactions are recorded before money actually changes hands. So accounts receivable and accounts payable must be adjusted to account for the actual flow of cash. Similarly, money that's been set aside for taxes, but not spent yet, needs to be added back in. Of course, you still must account for the money coming in from funding or paid back to sources of funding, as well as any assets purchased or sold.
Getting the best results isn't just about knowing how to forecast cash flow, you must also have a proper system in place for actually managing the calculations. Which brings us to the meat of this post. By following these three best practices, you can help ensure that your cash flow forecast is as accurate as possible, regardless of which method you decide to use.
You can't accurately forecast what money will be coming in and going out if you don't also accurately plan your finances for the time period being considered.
Doing anything inconsistently will give you inconsistent results. Cash flow forecasting is no exception. Once you decide to do it, maintaining the data should become a regular part of your operation.
There are many errors that can be made in cash flow forecasting. Using automation tools and practical accounting forecasting software will drastically reduce the chances of those errors occurring.
It's simple to get started building a cash flow model with this free template. With this template you can:
You can start by simply navigating to the Transactions tab of the spreadsheet and keeping the data filled in. With this, you'll be able to generate a cash flow model as well as several other useful metrics. The data in the transactions tab will allow you to record your subscription and one-time revenue using highly detailed reporting that will power the other reports to give you a very granular look at your finances. This information will help you make more informed decisions about a wide variety of business operations.
The template above is a great way to get started tracking important metrics about your business, but it still requires a lot of manual work. We can help. ProfitWell Metrics subscription analytics can help automate all of your subscription reporting, eliminating human error. Our powerful—and free—subscription analytics tool was designed specifically with the needs of SaaS businesses in mind. It will provide you with accurate, real-time reporting and analytics—everything you need to know to keep growing—all in one place.
Direct cast flow forecasting is calculated by plugging in cash inflow and outflow directly. Indirect forecasting works, instead, by taking the net income and adding or subtracting categories of items to account for the difference between items calculated on an accrual basis versus the actual exchange of cash.
Cash flow forecasting allows you to get a more complete picture of your company's financial health. You'll be able to more accurately plan for future expenses, predict negative cash flow, and see when other potential cash flow problems will arise well in advance, so you can prepare for them.
A cash flow forecast is created by estimating what your income will be over a given period of time and subtracting away expected and planned expenses. This can either be direct, based on actual cash flow, or indirect, based on net income and accrual entries adjusted for the flow of cash.