Everything You Need to Know About Cash Flow Forecasting

Jun 2, 2022 by Sage Thee

What is cash flow forecasting?

In its simplest terms, cash flow forecasting is the process of gathering an estimate (or forecast) of a company’s future financial position. Typically based on anticipated payables and receivables, forecasting your cash flow requires estimating your future sales and expenses to get an idea of how your business will be doing financially in the coming months.

The benefits of a cash flow forecast

A cash flow forecast is crucial for any business because it tells you if you’ll have the needed revenue to run the business or even expand it. It also allows you to see if more cash is going out of the company than in and identify the problem areas so you can reverse that cash drain.

How to forecast your cash flow

1. Identify your forecasting objectives

To make sure you can glean actionable insights from your cash flow forecast, first, you need to determine the business objectives that the forecast will support. We’ve rounded up the most commonly used cash forecasts for the following five objectives:

Growth planning:

This objective is all about ensuring your business has enough working capital to fund activities and projects that will help grow your company’s revenue.

Liquidity risk management:

Fostering visibility for potential issues that may arise in the future, such as more cash going out of your business than in, so that you have adequate time to address them.

Interest and debt reduction:

Debt can be an unavoidable fact of running a business. If your objective is interest and debt reduction, your cash flow forecast will enable you to ensure your business has enough revenue on hand to make payments on any loans or debt it’s taken on.

Short-term liquidity planning:

Make sure your business can meet its short-term obligations by managing the amount of cash available daily.

Covenant and key date visibility:

This objective is best for forecasting your cash levels for key reporting periods like year, quarter, or month-end.

2. Choose your forecasting period

Now that you have identified the business objective your cash flow forecast will support, the next step is to determine just how far into the future your forecast will look. Choosing the right reporting period can significantly impact the accuracy and reliability of your forecast. As a general rule, the further into the future your forecast looks, it’s likely to be less detailed. Here are the four most common forecasting periods and the objectives they’re most suitable for:

Short-term forecasts:

Best suited for short-term liquidity planning where day-to-day granularity is crucial to your business’s financial responsibilities, short-term forecasts usually look two to four weeks into the future and include a daily breakdown of payments and receipts.

Medium-term forecasts:

Extraordinarily helpful for interest and debt reduction, key date visibility, and liquidity risk management, medium-term forecasts typically look two to six months into the future. Most companies utilizing a medium-term projection use the rolling 13-week cash flow forecast.

Long-term forecasts:

Looking six to twelve months ahead, long-term forecasts are often the starting point for annual budgeting processes. A long-term forecast is also an essential tool for assessing how much cash is required for long-term growth objectives and projects.

Mixed-term forecasts:

Most commonly used for liquidity risk management, mixed-term forecasts utilize a mix of the three periods mentioned above. For example, a mixed-term forecast might provide weekly forecasts for the first three months and then monthly forecasts for the following six months.

3. Decide on a forecasting method

Choosing the correct method relies on the forecasting window you decided on above and the data you will have available to build your forecasting model. There are two main cash flow forecasting methods: direct and indirect. Direct forecasting uses actual flow data and is best utilized for short-term forecasts. Indirect forecasting is better suited for long-term forecasting and relies on projected balance sheets and income statements.

4. Gather the data you need for your cash flow forecast

Before putting your forecast into action, the final step is gathering the needed data. Most if not all of the data you will need will be found in your AR and AP ledgers or — even better — directly in your ERP or other accounting software your business uses. You’ll want to gather the following information from those systems:

  • Opening cash balance for the forecasting period
  • Cash inflows for the forecasting period
  • Cash outflows for the forecasting period

With this data and the proper forecasting method, you will be able to forecast your business’s cash flow accurately, identify problem areas, and plan for the future.

Not sure where to start or which forecasting method is suitable for your business? We’ve gathered a few of our favorite templates to help you get started:

Simple Cash Flow Forecast Template

Simple Cash Flow Forecast Template

Small Business Cash Flow Forecast Template

Small Business Cash Flow Forecast Template

12-Month Cash Flow Forecast Template

12-Month Cash Flow Forecast Template

Daily Cash Flow Forecast Template

Daily Cash Flow Forecast Template

Quarterly Cash Flow Forecast Template

Quarterly Cash Flow Forecast Template

Three-Year Cash Flow Forecast Template

Three-Year Cash Flow Forecast Template

Ready to learn more? Paystand’s Improving Cash Flow learning path has a wealth of resources that will help you reduce your DSO and improve operating cash flow.