Keys to Accurate Cash Flow Forecasting
While there is no “silver bullet” available to solve every company’s cash flow forecasting roadblocks, having the right processes in place is a good start. What and how you measure something will vary depending on your business, industry, and goals. For example, a seasonal business that generates 80 percent of its sales over just two months of the year will have different cash flow needs than one whose revenue is steadier throughout the year.
So, how do you go about producing an accurate cash flow forecast? Here are five tips that will help your organization bring more precision to the process, which will increase your company’s chances of survival and provide you with the resources you need to grow.
- Establish Lines of Communication
The consequences of an inaccurate forecast can be severe. A company might borrow more than it needs to meet conditions that don’t materialize. On the other hand, it could leave funds unnecessarily idle. The best way to avoid any type of liquidity crisis within your organization is to train top management in the importance of forecasting, as well as the mechanics of the process.
As with just about any other successful process within a company, communication is one of the keys to accurate cash flow forecasting. An effective forecast requires input from a variety of individuals throughout your organization who can provide important figures and valuable insights that will increase understanding of what drives the numbers. - Don’t Confuse Cash Flow with Revenue
Both revenue and cash flow are used as indicators to help investors or analysts evaluate the financial health of a company, but revenue provides a measure of effectiveness in sales and marketing, whereas cash flow is more of a liquidity or money management indicator.
Cash flow includes operational sales revenues and monetary sources beyond merely sales revenues. Companies often generate or obtain cash in a variety of ways that lie outside the conduct of their main business.
The critical importance of cash flow lies in the ability for a company to remain functional; it must always have sufficient cash to meet short-term financial obligations.
While sales revenue is only a measurement of a one-way inflow of money and no other type of transaction, cash flow is a measurement of cash that comes into a company in the form of sales as well as other methods. Therefore, unlike revenue, cash flow has the possibility of being a negative number or value.
- Identify Your Inflows and Outflows
For any CFO, much of this is elementary, but your cash flow forecast should be a detailed look at your company’s cash position relative to its inflows and outflows. To start, how much money will you be bringing in over the period in question and from what sources? This isn’t a measure of your company’s capacity to produce products or services, but rather what will be collected in payment for goods and services.
Historical sales data is a good place to start, but this must take into account macroeconomic factors such as consumer confidence levels and even small business confidence if you rely on B2B sales. Obviously, sales won’t always be consistent, so those communication channels you developed will give you valuable insight into other factors and business drivers that could impact these numbers.
- Create Several Scenarios
When you produce a cash flow forecast, it may be helpful to create several different scenarios. Let’s assume that you work in an industry where a potential tariff could undermine your future business. It hasn’t happened yet, but it would be helpful to know what your cash situation is going to be should this occur.
When you create multiple scenarios with your company’s future cash flows, you will be able to visualize the impact of certain future conditions, as well as quickly adapt your company’s processes when necessary. Provided you have automated your forecasting process, these scenarios should be simple enough to produce so that you won’t have to scramble in a reactionary mode at a later date.
- Publish, Monitor, and Adjust Results
No cash flow forecast should be set in stone, since there may be customers who fail to pay, sales that don’t materialize, or unexpected expenses that show up on your doorstep. Once you publish a forecast, continue to monitor results in real time as much as possible. Doing this will allow you to identify opportunities to improve your process and may permit you to take advantage of a better cash position on occasion.
Since few companies will hit their forecast on the mark, the measure of cash flow accuracy is one of degrees. As a company, decide what sort of variance is acceptable and aim to reach that goal. For example, you may be comfortable with a 5% variance overall but have different targets for certain categories.
Most organizations don’t have the financial strength to survive even a short-term cash flow crisis, so having accurate forecasts on hand is essential. When you have these working reports available, you and your management team can monitor your company’s results and adjust your plan as needed. Large and complex organizations should prepare a monthly forecast that extends a minimum of six months and preferably out to a year.
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