Cash flow forecasting is the process of estimating the amount of money that will flow into and out of a business over a specific period of time. It is a key component of cash budgeting, which is the process of planning and managing cash flow to ensure that a business has enough cash to meet its financial obligations.
Why is cash flow forecasting important?
Cash flow forecasting is important because it helps businesses to:
- Avoid cash flow problems:?Cash flow problems can occur when a business does not have enough cash to meet its financial obligations, such as paying its employees and suppliers. Cash flow forecasting can help businesses to identify potential cash flow problems in advance, so that they can take steps to avoid them.
- Make better financial decisions:?Cash flow forecasting can help businesses to make better financial decisions, such as when to invest in new projects, when to hire new employees, and when to borrow money.
- Improve profitability:?Cash flow forecasting can help businesses to improve their profitability by identifying areas where they can reduce costs or increase sales.
How to create a cash flow forecast
There are a number of different ways to create a cash flow forecast. However, most cash flow forecasts include the following steps:
- Gather data:?The first step is to gather data on the business's historical cash flows. This data can be obtained from the business's accounting records.
- Estimate future cash inflows:?Once the business's historical cash flows have been gathered, the next step is to estimate future cash inflows. This can be done by forecasting the business's sales and other sources of income.
- Estimate future cash outflows:?The next step is to estimate future cash outflows. This can be done by forecasting the business's expenses, such as the cost of goods sold, operating expenses, and debt payments.
- Calculate net cash flow:?The final step is to calculate net cash flow. This is done by subtracting cash outflows from cash inflows.
Different types of cash flow forecasts
There are a number of different types of cash flow forecasts that can be created. The most common type of cash flow forecast is a monthly cash flow forecast. This type of forecast shows the business's expected cash inflows and outflows for each month over a specific period of time, typically 12 months.
Other types of cash flow forecasts include:
- Weekly cash flow forecast:?This type of forecast shows the business's expected cash inflows and outflows for each week over a specific period of time.
- Quarterly cash flow forecast:?This type of forecast shows the business's expected cash inflows and outflows for each quarter over a specific period of time.
- Annual cash flow forecast:?This type of forecast shows the business's expected cash inflows and outflows for each year over a specific period of time.
How to use cash flow forecasts
Once a cash flow forecast has been created, it should be used to manage the business's cash flow. This can be done by comparing the actual cash flows to the forecasted cash flows. If there are any significant differences, the business can take steps to correct the situation.
Cash flow forecasts can also be used to make better financial decisions. For example, a business can use a cash flow forecast to determine whether it has enough cash to invest in a new project or to hire a new employee.
Here are some tips for creating and using cash flow forecasts:
- Use historical data:?When creating a cash flow forecast, it is important to use historical data to estimate future cash inflows and outflows. This will help to ensure that the forecast is as accurate as possible.
- Be realistic:?It is important to be realistic when creating a cash flow forecast. This means taking into account all of the factors that could affect the business's cash flow, such as seasonal fluctuations in sales and unexpected expenses.
- Update the forecast regularly:?Cash flow forecasts should be updated regularly to reflect changes in the business's operations and financial situation. This will help to ensure that the forecast is always accurate.
- Use the forecast to make decisions:?Cash flow forecasts should be used to make better financial decisions. For example, a business can use a cash flow forecast to determine whether it has enough cash to invest in a new project or to hire a new employee.
Cash flow forecasting is a key component of cash budgeting. It helps businesses to avoid cash flow problems, make better financial decisions, and improve profitability. By creating and using cash flow forecasts, businesses can better manage their finances and ensure their long-term success.
