Cash flow forecasting is the process of estimating the flow of cash into and out of a business over a period of time. Accurate cash flow forecasting helps companies anticipate future cash positions, avoid crippling cash shortages, and generate revenue from any cash surpluses they may have in the most efficient way possible.
Cash flow forecasting is usually the responsibility of a company’s finance team. However, the forecasting process requires input from multiple stakeholders and data sources within the company, especially in larger companies.
How to forecast cash flows
The best way to forecast cash flow for your business depends on your business goals, the requirements of your management team or investor, and the availability of information in your organization.
For example, a company trying to get an overview of contract positions at the end of the quarter will need a different forecasting process than a company that needs to manage debt repayments on a weekly basis. Here’s the process we recommend for creating a cash forecasting model, as well as what kinds of data you’ll need access to in order to do so.
Note: For large/multinational organizations, creating a cash flow forecast is a very challenging process. If you are creating a forecasting process for this type of business, our guide to setting up Cashflow Forecasting covers the process below in more depth.
Note: For large/multinational organizations, creating a cash flow forecast is a very challenging process. If you are creating a forecasting process for this type of business, our guide to setting up Cashflow Forecasting covers the process below in more depth.
1. Choose your forecast period
Once you’ve determined the business goal you want to support with a cash flow forecast, the next thing to consider is how far into the future your forecast will look.
In general, there is a trade-off between information availability and forecast duration. This means that the further into the future the forecast looks, the less detailed or accurate it is likely to be. So choosing the right review period can have a big impact on the accuracy and reliability of your forecast.
Here are the forecast periods we recommend and the trading objectives they are best suited for:
Short-Term Forecasts: Short-term forecasts usually look two to four weeks into the future and include a daily breakdown of cash payments and income. As you might expect, short-term forecasts are often best suited for short-term liquidity planning, where day-to-day detail is important to ensure the business can meet its financial obligations.
Medium-Term Forecasts: Medium-term forecasts typically look two to six months into the future and are extremely useful for reducing interest and debt, managing liquidity risk, and providing insight into key data. The most common medium-term forecast is a rolling 13-week cash flow forecast.
Long-range forecasts: Longer-range forecasts typically look 6-12 months into the future and are often the starting point for annual budgeting processes. They are also an important tool for assessing the cash needed for long-term growth strategies and capital projects.
Mixed Period Forecasts: Mixed Period Forecasts use a combination of the three above periods and are commonly used to manage liquidity risk. For example, a mixed-period forecast might provide weekly forecasts for the first three months and then on a monthly basis for the next six months.
2. Select a forecast method
There are two basic types of forecasting methods: direct and indirect. The main difference between the two is that direct forecasting uses actual flow data, while indirect forecasting relies on projected balance sheets and income statements.
Choosing the right forecasting method depends on the cash flow forecast window you selected above, as well as the type of data you have available to build your forecasting model. Here’s a breakdown of what each method is most effective for:
3. Source the data you need for your cash flow forecast
Direct forecasting provides the most accuracy and works for most of the business goals that companies create forecasts to support. Therefore, in this section we will focus on where to find the actual cash flow data for your forecast.
Ultimately, the right place(s) to source cash flow data for your forecast depends on how your business manages its finances. But generally speaking, most of the actual cash flow data you’ll need to build a forecast can be found in your bank accounts, accounts payable, accounts receivable, or the accounting software you use.
Here’s what you’ll want to get out of these systems:
Your starting cash balance for the forecast period: Usually taken from the most current and most accurate reflection of current positions.
Your cash flow for the forecast period: Expected sales revenue for the forecast period is usually the primary data source for your cash flow. Other types of cash inflows to consider include intercompany financing, dividend income, divestment proceeds, and inflows from third parties.
Your cash flows for the forecast period: We recommend capturing wages and salaries, rent, investments, bank fees and debt repayments. However, you can include anything that is relevant to your business.
Example of a cash flow forecast (medium term/13 weeks)
The 13-week cash flow forecast is the most common forecast because it provides the best balance of accuracy and forward-looking. Here’s an example of what a rolling 13-week cash flow forecast from forecasting platform CashAnalytic actually looks like:
Benefits of cash flow forecasting
In addition to ensuring that a business avoids cash shortages and earns a return on any cash surpluses, cash flow forecasting helps businesses thrive in other ways, such as:
We help businesses get out of debt faster: Debt repayments are often large cash outflows that need to be planned for. A cash flow forecast can help businesses that are in debt ensure that they have the cash to make those payments (and any interest payments associated with that debt) each time they come due.
Ensuring businesses comply with debt covenants they may be liable for: Debt covenants are financial restrictions placed on a business by a creditor. For example, some lenders require a business to maintain certain levels of cash to ensure it is financially sound enough to pay back what it owes on a regular basis. A cash flow forecast can help businesses identify potential cash flow problems that could lead to a breach of contract, which could require them to pay their loan balance in full on demand.
Enable businesses to grow more predictably: When a business grows through investment, it usually burns cash flow to do so. As cash flow forecasts help businesses plan their cash surpluses more effectively, they also facilitate the execution of a growth strategy in a more predictable manner.
How automation can make cash flow forecasting more efficient
Large companies often invest a lot of time and energy in forecasting at the enterprise and business level. However, most of this time is spent on low-value activities, such as gathering and manipulating data in spreadsheets, rather than high-value activities, such as extracting useful insights from their data.
