What is Cash Flow Forecast?

Forecast of anything is to predict or have estimation about the future happenings and in the context of corporate finance; cash flow forecasting is the modeling of a company or entity’s future financial liquidity over a specific timeframe and having an up-to-date cash flow forecast lets you anticipate your future cash position and also prepares you for any unexpected shortfall.

Understanding cash flow of your organization is very important because as the famous saying goes – cash is the king and anything and everything under the sun is governed and controlled by it, especially when we are talking about business and its operations. Cash flow is the life blood of all businesses and having a cash flow forecast is not only important for multi-national companies but it is also equally or at times more important for start-ups and small enterprises.

To have a cash flow forecast, a business or a firm can usually start by having a detailed estimation of its earning through sales or other activities and then having an estimation of how much it expects to spend in its day-to-day running activities and also any expected income from other sources. In today’s dynamic world where everything is changing on a daily business, uncertainty related to business operations are on the higher side and thus having a cash flow forecast will keep you buckled up and helps in taking precautionary as well as mandatory measures to save yourself and the business from last minute running out.

Why use a Cash Flow Forecast?

A good cash flow management is very important to run your business successfully and without any hiccups and allows you to pay your bills on time while payment from other sources and customers is still awaited and there have been several cases in the history of corporate world where a business has failed not because of low-profit margins but because of poor cashflow management. Having said so, it doesn’t mean that you do not focus towards making profit because the prime reason why you are in a business is to make profit, however amidst your desire of chasing your dream of building multinational empires, you must remember that there is a time lag between you sow the seeds and harvest the fruits i.e. from the time you start the operations i.e. providing goods and services till the time you start getting paid for the same and that’s where you have to be smart enough with cash flow i.e. you have to make sure that you have sufficient cash in your hand or in company’s account to cater for the daily operations bill and expenses related to invoices from suppliers, salary of employees, taxes and VAT, rent etc and this can only happen if you have predicted or forecasted the cash flow well in advance, preferably well before you started with the operations.

Cash flow forecast is not only important when you are starting a business but it is equally important when your business is well settled and has started to make profits. Because even if your business has started to make its profits, cash crunch or shortage may happen especially when you are awaiting payment for a bulk order and thus you should stick to the general principle of cash flow management which says that you should always expedite cash inflows i.e. payment from the customers, interests from the bank accounts etc and slow down cash outflows such as purchase of stock and equipment, loan repayments etc provided it is within reasonable time limit.

Although it is advisable to have cash flow forecasts on monthly basis, it is highly recommended and would do wonders to your business if you can have one in place on a fortnight basis and as a matter of fact, lot of businesses operates on having a day-to-day cash flow forecast, especially when tighter financial control is needed.

Why are Cash Flow Forecasts important for your business?

A cash flow forecast can help your business in lot of ways, such as:

  • It helps new businesses to identify how much capital they have and need to start up costs and cover initial operations,
  • Enable to identify potential short fall in income and allows you to take immediate action,
  • Help you to decide in case you need a loan or an overdraft.
  • Keeps you in check and within financial limits.
  • It helps you to identify potential increases in costs and also to take appropriate action.
  • If you have done your cash flow forecast well in time, then it gives you essential financial information before you take on additional financial commitments.
  • It also helps you to see the period of time over which you are required to take out finance and the amount you can afford to pay back each month.
  • A good cash flow forecast will show if your business is meeting the desired expectations and if not, you can compare the cash flow forecast with your actual income and expenses and can identify areas of concern and the areas or department are either under or over performing and act required actions.
  • If you are planning to make any minor or major changes to your business plan, you can use the cash flow forecast to understand the effects of the proposed or desired changes. For example, if you are planning to do some major hiring or increase salary of the employees, you can make cash flow forecast to see how the changes are going to affect your business. (Read Also: Employment and Hiring Procedure)
  • With the help of a cash flow forecast, you can run a hypothetical business and can predict any possible cash surpluses or shortages and thus will be able to make more informed and practical business decisions. Also you can run best and worst case scenarios to the behavior of your business both during the best and worst time and thus with some effective cash flow forecasting, you can totally avoid the situation where your business may go insolvent or where its liabilities exceeding its assets.

What should be included in the cash flow forecast?

For a business to maintain financial stability, it is important to have a good cash flow management and there could be no better way to have a well thought cash flow forecast in place. A good cash flow forecast should have below mentioned elements:

Likely Sales or Sales Forecast

The very first step towards creating a cash flow forecast is to estimate or foresee your likely or expected sales and you can do so by having a look at your sales history, unless you have done some major changes in your business plan or operations. In case you are just starting your business, then in order to have a sales forecast, you can refer to the data from the suppliers, competitors and industry experts and while you do so, you must consider your future business plans as well, if applicable at that point of time. Apart from your business plans and business history, you must also include factors such as activity of competitors, possible contracts you are hoping to win, any product launches and promotional activity.

Profit and Loss Forecast

A profit and loss forecast would give you an idea regarding your business income and its day-to-day running costs and thus would give you an insight about future. In case you can estimate or predict how much profit you are going to make, you will get a fair idea about the applicable tax on the same and thus you can estimate you profit. Also in case you are planning to venture into new markets, you have to cater for extra cost demand and you could find yourself at increased risk of running out of cash and thus you can plan for dealing with a cash crunch or shortage if the need arises.

Projected Payment Timings

While creating a cash flow forecast, you need to place timeline when the payments are expected and even if you know the exact date of payment, you must factor a possible delay of 2 weeks for most of the payments.

Projected Costs

By the time you reach here, you would have fair idea of expected income and its timings so now you need to factor or estimate your outgoings or expenses and while doing so, you must cater both for the fixed and variable costs, which will include the following :

  • Fixed costs include the cost which are fixed and doesn’t undergo much of a change such as rent and salaries and in order to include the fixed costs in projected costs, you can include the payment date and projected amount, bills, memberships and tax payments.
  • Variable costs are dependent on the sales and thus vary accordingly and thus need to be included in the cash flow forecast as per the estimated sales plan.

An effective cash flow forecast will not help you to have a fair idea of how your business is going to flair and also to have contingency plan ready but will also helps in building your brand name because it will ensure that your suppliers and employees are paid on time.