Cash Flow Forecasting for Business Success

Cash flow forecasting is a crucial tool for businesses to manage their finances effectively. By accurately predicting inflows and outflows of cash, businesses can make informed decisions about investments, hiring, and expansion.

A well-planned cash flow forecast can help businesses avoid cash shortfalls and take advantage of opportunities. For instance, a company with a reliable cash flow forecast can invest in new equipment or hire additional staff when cash is available.

Regular cash flow forecasting also helps businesses to identify potential cash flow issues before they become major problems. This proactive approach enables businesses to make adjustments and mitigate the impact of cash flow shortfalls.

To create an effective cash flow forecast, businesses should consider factors such as sales projections, payment terms, and seasonal fluctuations.

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Your cash flow forecast should support a specific business objective. You'll want to identify the purpose of your forecast to ensure it provides actionable insights.

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Organizations most commonly use cash forecasts for short-term liquidity planning, managing the amount of cash available on a day-to-day basis to meet short-term obligations.

Interest and debt reduction is another common objective, ensuring the business has enough cash on hand to make payments on loans or debt.

You may also want to project cash levels for key reporting dates, such as year, quarter, or month-end, for covenant and key date visibility.

Liquidity risk management is also a crucial objective, creating visibility into potential liquidity issues that could arise in the future.

Growth planning is another important objective, ensuring the business has enough working capital on hand to fund activities that will help grow revenues in the future.

Here are some common objectives of a cash flow forecast:

The length of your cash flow forecast can make a big impact on its accuracy and reliability. Generally, the further into the future the forecast looks, the less detailed or accurate it's likely to be.

There's a trade-off between the availability of information and forecast duration. Choosing the right reporting period is crucial to ensure your forecast meets your business needs.

Short-term forecasts typically look two to four weeks into the future and are best suited for short-term liquidity planning. This level of granularity is important to ensure a business can meet its financial obligations.

Medium-term forecasts, on the other hand, look two to six months into the future and are useful for interest and debt reduction, liquidity risk management, and key date visibility. A common medium-term forecast is the rolling 13-week cash flow forecast.

Long-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 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.

Here are the forecasting periods we recommend and the business objectives they're best suited for:

Direct forecasting is the most accurate method, but it's often unreliable for reporting periods longer than 90 days due to limited actual cash flow data availability.

There are two primary types of forecasting methods: direct and indirect. Direct forecasting uses actual flow data, while indirect forecasting relies on projected balance sheets and income statements.

The right forecasting method depends on the cash flow forecasting window and the data you have available to build your model. Generally speaking, direct forecasting provides the greatest accuracy.

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Direct forecasting uses actual flow data, which is often the most accurate method.

However, this method can be unreliable for reporting periods longer than 90 days because actual cash flow data isn't always available beyond that window.

You have two primary types of forecasting methods to choose from: direct and indirect.

Direct forecasting is generally the most effective method, but it depends on the data you have available to build your forecasting model.

A three-way projection is essentially a combination of three reports: cash flow statements, profit and loss, and balance sheet forecasts. This comprehensive approach helps you predict future cash shortages, expected profitability, and what your business owns and owes.

A cash flow statement will give you a closer look at your business's cash flow, while a profit and loss statement will show you your expected profitability compared to the previous period. This includes revenue, cost of goods and services, and net profit.

A three-way projection is vital to the future planning of your business, as you'll be able to use different scenarios to create a more comprehensive understanding of what may happen to your business over the coming few years. This will give you a better understanding of what works well and what needs to be tweaked.

Here are the three components of a three-way projection:

By combining these three reports, you'll get a complete picture of your business's financial situation, allowing you to make informed decisions and adjust your strategy as needed.

To create a cash flow forecast, you need to source the right data, which can be found in bank accounts, accounts payable, accounts receivable, or accounting software. Most businesses manage their finances through these systems, making it easier to pull the necessary information.

You'll want to focus on pulling your opening cash balance for the forecasting period, which is usually the most up-to-date and accurate reflection of current positions. This is a crucial starting point for your forecast.

Other data to consider pulling includes cash inflows and outflows for the forecasting period. Cash inflows can come from sales receipts, intercompany funding, dividend income, proceeds of divestments, and inflows from third parties. You should also capture cash outflows such as wages and salaries, rent, investments, bank charges, and debt payments.

To make your forecast more accurate, consider the following factors:

Here's a summary of the key data points to pull:

Creating a forecast is a crucial step in cash flow forecasting. You can start by choosing between two different methods: the direct forecasting method, which is useful for short-term forecasting based on future cash inflow and outflow, or the indirect forecasting method, which is used for long-term forecasting aligned with a business's goals and strategy.

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Fathom uses the indirect cash forecasting method to help with long-term planning up to three years in the future. To get started, you can start from scratch to build a custom cash flow forecast, use the Quick Start Forecast, or link your cash flow forecast to an existing budget.

There are three ways to get started with Fathom's cash flow forecasting software. You can start from scratch, use the Quick Start Forecast, or link your cash flow forecast to an existing budget.

Here are the three ways to get started with Fathom's cash flow forecasting software:

Cash flow forecasting is essential for every business, and its benefits can't be overstated. It helps you identify potential problems and make necessary changes to avoid cash deficits.

A cash flow forecast can predict months when you might experience a cash shortage, allowing you to plan for them by saving more in surplus months, stepping up receivables collection efforts, or establishing a line of credit with your bank.

Late payments and missing paychecks can damage your reputation with suppliers and employees. With a cash flow forecast, you can confirm that you'll be able to meet your payroll obligations and pay suppliers on time.

Cash flow forecasting has several benefits, including less stress about where your money will come from, the ability to identify problems and plan for times when you might be low on cash, and greater confidence paying your staff and suppliers on time.

Here are some of the key benefits of cash flow forecasting:

Cash flow forecasting also helps businesses get out of debt faster, ensures they adhere to debt covenants, and enables them to grow more predictably.

Cash flow forecasting can be a daunting task, especially when dealing with multiple countries and currencies. Forecasting can be an arduous and time-consuming process, particularly if it's based on spreadsheets and involves manual data collection.

This can result in errors, inconsistencies, and a lack of cooperation from internal stakeholders. Manual data collection processes may also run the risk of data inputting errors and inconsistencies.

Companies can improve the data collection process and make use of technology to maximize the accuracy and timeliness of the resulting forecast. Sophisticated cash forecasting solutions can use both live and historical data on the company's payables and receivables, alongside technologies such as machine learning.

These solutions can provide fast and accurate near-real-time forecasts, taking into account not only current purchase orders, payables and receivables, but also behavioral patterns such as invoice approval times.

Here are some common challenges associated with cash flow forecasting:

By addressing these challenges, companies can improve the accuracy and timeliness of their cash flow forecasts, and make more informed business decisions.

Forecasts can be notoriously difficult to create, particularly if your business operates across multiple countries and currencies. Manual data collection can be a major time sink, taking several hours or even days to generate a single forecast.

Time-consuming forecasting processes can be a significant challenge, especially when relying on spreadsheets. The average time taken to generate a complete forecast in Excel can range from several hours to several days.

Manual data collection also increases the risk of errors and inconsistencies, which can be costly and time-consuming to rectify. Inconsistent data can lead to inaccurate forecasts, which can have serious consequences for your business.

Without sophisticated forecasting tools, the process can be unwieldy and prone to errors. This can lead to a lack of trust in the forecast, making it harder to make informed business decisions.

Here are some of the common challenges associated with forecasting:

Cash flow forecasting solutions can help companies forecast their future cash flows with greater accuracy.

Sophisticated cash forecasting solutions can use both live and historical data on the company's payables and receivables.

These solutions can take into account not only current purchase orders, payables and receivables, but also behavioral patterns such as invoice approval times.

Visualization tools can help companies understand the forecast quickly and easily.

Cash forecasting tools that integrate seamlessly with the company's ERP instances around the world can reduce the challenges associated with gathering information from disparate sources.