Managers and business owners are often too busy handling the daily operations of their businesses. Yet, they need to look ahead and plan ahead, as that is also crucial for the overall well-being of their business. Day-to-day decisions help with immediate needs, while long-term planning helps shape the business's strategy.
Cash flow forecasting is a tool that helps with this strategy. It predicts how much cash the business will have in the future. Since having enough cash is a key sign of a healthy business, you can see why predicting cash flow is so important.
Understanding Cash Flow Forecasting
Cash flow forecasting involves adding up all the money you expect to come in and go out. This helps you understand your cash situation and plan for the future. By doing this, businesses can make sure they have enough money to pay their bills and stay financially healthy.
Pros of Cash Flow Forecasting
Offers Cash Insights
In cash flow forecasting, it's crucial to clearly understand your cash coming in and going out. This means having a detailed look at your money movements.
Identifies Issues
Being proactive in spotting any cash shortages is key. A good cash flow forecast lets you see these issues before they happen.
Helps in Investment
You can use your cash flow predictions to make smart financial choices. Knowing your cash flow helps decide how much you can invest in growing your business.
Cons of Cash Flow Forecasting
Cash flow forecasts are mostly beneficial, but keep in mind they're only projections. They can't guarantee your business's future with total certainty – nothing can.
Like how a weather forecast gets less precise the further it looks ahead, the same goes for cash flow forecasts. Your business predictions might be spot-on, but factors like the wider economy can still influence the actual results.
How Do You Derive The Value of Cash Flow Forecasting?
To get the value from Cash Flow Forecasting, you need to know what goes into a cash flow forecast. But keep in mind that the details can vary based on your business.
Cash Inflows
For a cash flow forecast to be accurate, it should include all sources of incoming cash. Here are some typical examples of cash inflow:
- Revenue from sales
- Interest gained
- One-time sales
- New fundings
- Sale of assets
Cash Outflows
Just like cash inflows, it's important to consider both obvious and less visible sources of cash outflow. This varies by business. But common outflows include:
- Daily expenses
- Taxes
- Small fees/payments
- Purchase of assets
What Are the Methods of Forecasting Cash Flow?
There are two main methods for cash flow forecasting:
Direct Method
This approach involves directly inputting cash inflows and outflows. It's less common, particularly for companies using accrual-basis accounting and not cash-basis accounting.
Indirect Method
Indirect forecasting starts with the net income. Then, it adjusts for items to bridge the gap between actual cash transactions and accrual basis calculations.
What Are the Best Practices for Forecasting Cash Flows?
To get the best results from cash flow forecasting, it's not just about knowing how to do it. You also need a good system for managing the calculations. Following these best practices can help make your cash flow forecast more accurate:
Plan Your Finances Well
You need a clear financial plan for the period you're forecasting. You can't predict cash flow accurately without a good understanding of your expected expenses and income.
Be Consistent in Reporting
Consistency is key. Inconsistent practices lead to unreliable results. Once you start cash flow forecasting, it should become a regular part of your business routine.
Use Automation to Reduce Errors
There are many potential mistakes in cash flow forecasting. By using reliable accounting software and automation tools, you can significantly lower the risk of these errors.
How Do You Generate Cash Flow Forecast in a Subscription Business?
In a subscription-based business like SaaS, creating a cash flow forecast involves projecting three types of cash inflows. These include cash from:
- Existing subscription contracts
- New contracts or sales
- Future renewed terms or contracts
