Cash flow Projections

Cash flow forecasting is the process of estimating the flow of cash in and out of a business over a specific period of time. An accurate cash flow forecast helps companies predict future cash positions, avoid crippling cash shortages, and earn returns on any cash surpluses they may have in the most efficient manner possible.

Cash flow is the amount of money going in and out of your business. Healthy cash flow can help lead your business on a path to success. But poor or negative cash flow can spell doom for the future of your business.

If you want to predict your business’s cash flow, create a cash flow projection. A cash flow projection estimates the money you expect to flow in and out of your business, including all of your income and expenses.

Typically, most businesses’ cash flow projections cover a 12-month period. However, your business can create a weekly, monthly, or semi-annual cash flow projection.

Advantages of projecting cash flow

Projecting cash flows has many advantages. Some pros of creating a cash flow projection include being able to:

• See and compare business expenses and income for periods.
• Predict cash shortages and surpluses.
• Determine if you need to make adjustments. (e.g., cutting expenses)
• Estimate effects of business change. (e.g., hiring an employee)
• Prove to lenders your ability to repay on time.

Forecasting:

Determine Your Forecasting Objectives

To ensure you see actionable business insights from a cash flow forecast, you should start with determining the business objective that the forecast should support. We find that organizations most commonly use cash forecasts for one of the following objectives.

• Short-term liquidity planning: Managing the amount of cash available on a day-to-day basis to ensure your business can meet its short-term obligations.
• Interest and debt reduction: Ensuring the business has enough cash on hand to make payments on any loans or debt they’ve taken on.
• Covenant and key date visibility: Projecting your cash levels for key reporting dates such as year, quarter, or month-end.
• Liquidity risk management: Creating visibility into potential liquidity issues that could arise in the future so you have more time to address them.
• Growth planning: Ensuring the business has enough working capital on hand to fund activities that will help grow revenues in the future.

Choose Your Forecasting Period

Once you’ve determined the business objective you hope to support with a cash flow forecast, the next thing to consider is how far into the future your forecast will look.

Generally, there’s a trade-off between the availability of information and forecast duration. That means the further into the future the forecast looks, the less detailed or accurate it’s likely to be. So, choosing the right reporting period can have a big impact on the accuracy and reliability of your forecast.

• Short-period forecasts: Short-term forecasts typically look two to four weeks into the future and contain a daily breakdown of cash payments and receipts. As you might expect, short-term forecasts are often best suited for short-term liquidity planning, where day-to-day granularity is important to ensure a business can meet its financial obligations.
• Medium-period forecasts: Medium-term forecasts typically look two to six months into the future and are extremely useful for interest and debt reduction, liquidity risk management, and key date visibility. The most common medium-term forecast is the rolling 13-week cash flow forecast.
• Long-period forecasts: Longer-term forecasts typically look 6–12 months into the future and are often the starting point for annual budgeting processes. They’re also an important tool for assessing the cash required for long-term growth strategies and capital projects.
• Mixed-period forecasts: Mixed-period forecasts use a mix of the three periods above and are commonly used for liquidity risk management. For example, a mixed period forecast may provide weekly forecasts for the first three months and then on a month-to-month basis for the next six months after that.

Choose a Forecasting Method

There are two primary types of forecasting methods: direct and indirect. The main difference between them is that direct forecasting uses actual flow data, where indirect forecasting relies on projected balance sheets and income statements.

Choosing the right forecasting method depends on the cash flow forecasting window you selected above, as well as the kind of data you have available to build your forecasting model.

Source the Data You Need for Your Cash Flow Forecast

Direct forecasting provides the greatest accuracy and works for the majority of business objectives that companies build forecasts to support. Therefore, we’ll focus on where to find actual cash flow data for your forecast in this section.

The right places to source cash flow data for your forecast ultimately depends on how your business manages its finances. But, generally speaking, most of the actual cash flow data you’ll need to build your forecast can be found in bank accounts, accounts payable, accounts receivable, or the accounting software you use.

• Your opening cash balance for the forecasting period: This is normally taken from the most up-to-date and accurate reflection of current positions.
• Your cash inflows for the forecasting period: Anticipated sales receipts from within the forecasting period are usually the primary source of data for your cash inflows. Other types of cash inflows to consider including are intercompany funding, dividend income, proceeds of divestments, and inflows from third parties.
• Your cash outflows for the forecasting period: We recommend capturing wages and salaries, rent, investments, bank charges, and debt payments. But you can include anything that’s relevant to your business.