Forecasting Cash Flows

Cam McIntyre

Picking the right customers to trade with, implementing processes to ensure invoices will be paid on time, integrating cash flow management in all your investment decisions, or subscribing to a trade credit insurance policy can help protect your business against late payments or customer insolvency.

But it all starts with having an up-to-date cash flow statement and creating a cash flow forecast. Let’s have a look at how to calculate cash flow and how to make a cash flow projection.

Why is cash flow management crucial?

The top reason small businesses fail is low funds. An established business requires adequate access to capital to pay salaries and bills, as well as grow. Even companies that manage elevated sales volumes can become insolvent if cash flow is disrupted, for example in the event of unpaid invoices.

Your forecasting period will be every month and by creating a forecast for the next, you can spot trends to anticipate when your business might need more cash payments. This allows you to prevent future problems with cash flow and helps you plan ahead.

Cash flow forecasting

Before making a cash flow projection, it is important to first learn how to calculate cash flow. It can help with seasonal variations, cash inflows, and tax payments.

To calculate net cash flow, compare your total cash coming in with all the cash you are spending per time period (for example, three months).

The net cash flow formula is: Cash Received – Cash Spent = Net Cash Flow.

Cash received corresponds to your revenue from invoices that have been settled, and cash spent corresponds to a list of liabilities.

The cash flow forecast shows

To determine the amount of money that is available for you to spend, use the following free cash flow formula:

Net income + Depreciation – Change in working capital – Capital expenditures = Free Cash Flow

To help you use this formula, here are some common definitions:

  • ‘Net income’ The profit of a business is obtained by taking the revenue from sales and subtracting it from this number, the cost of goods sold.
  • ‘Depreciation’ is like scheduled expenses that cause the reduction of an asset's carrying or market value.
  • ‘Change in working capital’ refers to all of the company's liquid, spendable cash levels and other assets which can be quickly converted into cash. Current liabilities are expenses such as accounts payable that cannot be paid immediately without penalty.
  • ‘Capital expenditures’ are the funds used to acquire, upgrade and maintain physical assets.


What is the purpose of a Cash Flow forecast?

Knowing the state of your cash flow helps you prepare for changes and make better decisions. A cash position forecast can tell you how much money is coming into a company versus going out, which lets you know if the business will have a positive or negative cash flow at a specific point in time.

It is imperative that these cash flow forecasts are done correctly, with a logical cash flow forecast template, to ensure the company's overall health. How can you know if your business is healthy without doing this historically?

A well-designed forecast template should be able to help you calculate how much money coming in from sales and then subtracting out all of the expenses that go into creating those sales.

Why is it so important to a business for an accurate cash flow forecast?

Maintaining a continuous source of cash is crucial for any business to survive. If the funds saved runs out, it can lead to potential failure. 44% of small businesses fail within 4 years due to this reason.

Cash flow forecasting is an essential tool for businesses because it helps you notice trends and make proactive decisions about investing in expensive equipment before your cash runs out. Having cash surpluses is perfect for the new year so you can purchase raw materials for the company.

Advantages and Disadvantages of a cash flow forecast

Advantages of cash flow forecasts

There are a number of advantages to creating cash flow forecasts for businesses, such as:

  • Can help families create a budget they can afford.
  • It can help you determine how much can be paid off on existing loans.
  • It can help management make financial decisions or forecasts. (forward planning)
  • Is perfect for estimated sales in a particular area.
  • The report will help investors and shareholders review the stability of the company.
  • Will be perfect to predict variable costs


Disadvantages of cash flow forecasts

  • Despite the disadvantages, businesses should consider formal cash flow forecasts to help to manage expenditure.
  • Forecast cash flow is negatively affected by unforeseen factors, such as payment services regulations or technology changes.
  • The forecasts are estimates and are never entirely accurate, hence "forecast."
  • May provide a business with a false sense of security, these forecasts should be compared to the actual financial statements, such as profit and loss statements.


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