How to Forecast Cash Flow in Uncertain Times

How to Forecast Cash Flow in Uncertain Times… Nobody wants a budget that is far off target, especially when it could result in a liquidity crisis. Fortunately, most companies rarely experience such a stressful event. But in a turbulent economy where interest rates and stock indexes move up and down like yo-yos, and news about corporate layoffs are part of daily news headlines, strong financial clarity is more of a necessity than ever before.

What does a cash flow forecast mean to most people?

Here is one definition: A cash flow forecast is a plan that shows how much money a business expects to receive, and payout, over a given period of time.

Based on the definition above, it seems logical that all businesses should have a cash flow forecast perfectly established in their corporate processes, but is that the reality? Let’s take a closer look.

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What are Cash Flow Budgets?

Cash flow budgets are made up of several elements, including capital requirements, cost of goods, development expenses, operating expenses, and sales and revenue. Like every other quality budget, cash flow projections are based on past performance data. To forecast your cash flow, begin by looking at your estimated sales for the next year. Then, see what percentage of total business volume is produced in each individual month. Don’t forget to divide each month’s revenues into cash and credit sales.

Your cash sales can be recorded in a cash flow report in the same month they’re generated. Non-cash sales are more complicated because credit and debit card sales can’t be treated the same as cash. Rather, this type of transaction is based on invoices with agreed-upon terms. You will need to look at your AR (accounts receivable) records and calculate your typical collection period. You won’t be able to log credit sales as cash until 5-10 days after the payment period ends, because you are waiting on another bank to receive and process that payment.

Next up is other income. More specifically, the next line item on a cash flow statement is the revenue you get from investments, interest accrued on loans that have been extended, and funds acquired by liquidating any assets. The sum of cash sales, receivables, and other income is your total income. In your first month of cash flow budgeting, it will typically be comprised of cash sales, other income, and any receivables from the previous budget that have matured to a collection point during the first month of the current budget.

Do All Businesses Do Cash Flow Forecasting?

As much sense as it makes to have a good estimate of your future cash outflows and inflows, many companies never get around to doing a cash flow forecast. This is especially true in small and mid-sized businesses. Some reasons for this lack of cash flow forecasting models are as follows:

• The Financial Department doesn’t have time to prepare it
• Lack of tools that automate cash flow forecasting
• Level of complexity required to create a good cash flow model
• Past attempts were so far off there is little desire to try it again
• Other business tasks or crises keep executives focused on other areas
• The financial planning team is exhausted after the annual budget process, with no time or motivation to re-forecast the budget during the year

Regardless of the reason for not doing a cash flow forecast, healthy cash flow is the lifeblood of all businesses, so there should be no lack of motivation to implement it in nearly all companies. Let’s look at the potential benefits of accurate cash flow forecasting.

Why Do Companies Want to Project Their Future Cash Outflows and Inflows?

Most executives know they would sleep better at night if they had a mechanism that could tell them, within some range of accuracy, if the liquidity of their business will be healthy or not in the months to come.

Below is an example of a report using simple color indicators and charts to help managers analyze a company’s projected cash position based on the underlying cash flow forecast.

There are several very logical ways a company can benefit from regular cash flow forecasts, including:

1. Reduced risk of insolvency: By having a clear idea of any upcoming liquidity issues, management can react early and avoid drama and stress.
2. Ability to move faster on investment opportunities: If you, thanks to a cash flow forecast, know in advance that the business will be flush with cash in the months ahead, you can start planning acquisitions, make a down payment on high-interest debt, or purchase strategic capital assets, etc.
3. Improvement of financial relations: Satisfy bankers to enable debt financing or other bank-backed financial transactions

In other words, solid cash flow forecasts can be of tremendous value to a management team. But if so many financial teams dread the additional work of planning and performing a cash flow analysis, how do companies still get it done?

How to Automate Cash Flow Forecasts

As in so many other cases, technology helps us automate difficult and time-consuming tasks. In the case of cash flow forecasting, our software Inventoro uses vendors such as Workday Adaptive Planning (formerly Adaptive Insights) that specialize in planning, budgeting, and forecasting.

One major benefit is the automation of your cash flow tools, including scenario forecasting to predict “great”, “good” and “bad” scenarios so managers can plan accordingly.

Sometimes managers don’t have the time or need for a full forecast to analyze projected liquidity. In this case, they can use simulation models to quickly adjust elements of their cash outflows and inflows to see the impact on their cash position, as seen in the example below.

Most executives would agree that accurate cash flow forecasts provide numerous benefits to their business. During times of economic turmoil, cash flow forecasts can help lower the risk of running into liquidity problems, while at the same time increasing the chance to be ready to react to investment opportunities in a timely manner. Regardless of the motivation, there are tools available to automate and simplify financial planning processes. Using one like Inventoro is essential for most companies in today’s unsettled world.