Cash Flow Forecast (What It Is And How It Works: All You Need To Know)

What is a Cash Flow Forecast?

How can you do cash flow forecasting?

What are the essential elements you should know!

Keep reading as I have gathered exactly the information that you need!

What does a cash flow forecast mean and why is it so important!!

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Let’s get started!

What Is A Cash Flow Forecast

Cash flow forecast refers to the amount of money you anticipate collecting and having to pay out of your business.

In other words, when you are forecasting cash flows, you are trying to “anticipate” or “estimate” how much money your business will be cashing in over the course of a period of time and how much money it will need to pay out.

To forecast cash flows, you’ll need to identify all your business income (from all sources) and identify all your business expenses (for all aspects of your business) during a period of time such as a day, week, month, or year (or any other time period of your choice).

There are many benefits to having forecasted cash flows.

By having a good understanding of how much money you are expecting to receive and how much money you are expected to pay out, you can make better business decisions, such as:

• Purchasing decisions
• Tax decisions
• Financing decisions 
• Hiring decisions 
• Business expansion decisions 
• Capital purchase decisions 

Essentially, you’ll have a great idea as to your business’s current cash flows along with the impact of your business decisions in the future.

Cash Inflow And Outflows

The way you estimate your cash forecast is by estimating how much cash you will receive in a given period and how much cash you will disburse. 

Here are some possible incoming cash sources:

• Business operations (sale of products and services)
• Financing from debt securities
• Financing through equity securities 
• New loan financing 
• Investment proceeds 
• Sale of assets 
• Other income 
• Sales tax 

Here are some ways cash can be used by the company:

• Payment for cost of goods sold
• Payment of recurring bills
• Payment of special or one-time expenses 
• Loan payments 
• Cost to purchase an asset
• Non-operating expenses 
• Sales tax 

Cash Flow Forecast Definition

What is the definition of cash flow forecast?

What does it mean?

My definition of a cash flow forecast or cash flow forecasting is defined as follows:

In other words, a cash flow forecast means:

• An assessment
• Of a company’s 
• Future
• Cash flow position 

How Does Cash Flow Forecasting Work

Cash flow forecasting is generally handled by the company’s finance department or finance team.

The way it works is that the company accountant, controller, or other finance professional tries to estimate how much “cash” the company is expected to collect for a specific period of time and how much it will have to “disburse” during the same period.

Gather Business Information

More concretely, the company’s finance team must gather different pieces of information to be able to make an accurate forecast of the cash position of a company during a particular period, such as:

• Speak with company executives to better understand their business objectives and plans 
• Speak with the sales team to get a better understanding of the company’s sales pipeline and how much they are expecting to sell
• Speak with the account management team to see how many customers are currently being managed and if there will be any cross sales or upselling opportunities 
• See how long costumes take to pay their invoices 
• See how much money the company needs to fund its regular business operations
• See how much money the company may need to fund any special project or one-time capital expenditure needs 

As you can see, putting together a forecasted cash flow statement or document will require that the finance team have a very good understanding of the business and have accurate data to be able to make a good forecast.

Forecasting Objectives

To make a useful forecast, you’ll need to determine what are your forecasting objectives, meaning that you need to determine what is the main purpose for you to prepare a cash flow forecast.

Are you looking to prepare a forecast to manage your day-to-day cash availability (short-term liquidity planning)?

Are you looking to pay off debt?

Are you preparing your forecast for your lenders and financial institutions as part of your financial covenants, cash flow KPIs (key performance indicators), or key date visibility?

You may be looking at performing a liquidity risk analysis in order to prepare for cash shortages or significant expected cash expenditures.

Finally, you may be looking at growing your business, launching a new product, penetrating a new market, doing an acquisition, and you want to do proper growth planning to assess your cash requirements and needs.

Forecasting Period

Once you have determined the objective for which you are going to prepare a forecast, another key factor to consider is your forecasting period.

Choosing the period for your forecast requires that you make certain compromises in the accuracy and availability of the information in support of your forecast.

If your forecast is to look deep into the future, the accuracy of your forecast may not be good for distant periods.

On the other hand, if your forecast is too short-term, although you may have a very accurate forecast but, on the flip side, your forecasting horizon is short-lived and so you may not be able to make strategic business decisions.

You may want to look at preparing a short-term, medium-term, or long-term forecast (or even create mixed-period forecasts) depending on your business forecasting objectives.

Forecasting Method

The next decision you will need to make is to consider the forecasting method that you wish to use.

There are two cash forecasting methods:

• Direct cash flow forecasting method 
• Indirect cash flow forecasting method

When you perform direct cash flow forecasting, you are essentially using actual cash flow data to make your projections.

With an indirect cash flow forecasting method, you will take data points from your balance sheet and income statement to indirectly forecast your cash flow.

Typically, if you are doing a short-term cash flow forecast, you may want to use a direct method.

With the short term method, you can look at your working capital cash requirement by analyzing your short term receipts and payments.  

If you are looking to do medium or long-term cash flow forecasting, you may want to use the indirect method.

This way, you will be able to see your cash flows based on your business projects, growth strategies, capital projects, and future objectives by looking at your company’s net income, pro-forma balance sheet, and so on.

Data Source

The data you use to create your forecasted cash flow is quite important.

The more accurate data you have, the more your forecast can be accurate.

There are many places where you can find your data, such as:

• Business bank account 
• Accounts payable reports
• Accounts receivable reports 
• Accounting software or ERP system you use
• Sales pipeline tracked in your company CRM 
• Capital project data 

If you do not have actual data to support your forecast, you can make estimates by doing market research, gathering statistical data, doing a market study, looking into business plan data, gathering data from the company’s financial statements, and so on.

Benefits of Cash Flow Forecasts

What are the benefits of preparing a cash flow forecast?

In a nutshell, a business can be viewed as a series of cash flows coming in and going out.

All your business activities and operations require you to inject “cash” and “capital” to generate an income or “incoming cash flows”.

As such, properly managing your cash flow allows you to monitor the overall financial health of your business and make better-informed purchasing decisions or manage your expenditures.

A cash flow forecast allows you to:

• Predict cash surpluses and shortages 
• Decide when to hire employees and how much salary to pay
• Decide when to purchase new equipment 
• How much you can afford to pay for your office
• Create a business contingency plan in slower periods 

Another major benefit in forecasting cash flow is that you’ll be able to monitor how your business is evolving.

In other words, you can compare your business’s income and expenditure forecasts with your business’s actual cash inflows and outflows to see if your business is performing above your expectations or below it.

If you notice that your business is not doing as well as anticipated, you can then try to investigate further and make consequential business decisions.

If you have new competitors, you may want to allocate more money towards the marketing of your products and services, perhaps you may want to launch a new product, or invest further in research and development.

Here are some additional benefits in preparing a “cash flow forecast” or using a cash forecaster to assess your cash flow and financial position:

• Make strategic business decisions
• Get out of business debt 
• Respect business debt covenants 
• Allow your business to grow and scale 

How To Forecast Cash Flow

How can you forecast cash flows?

Here are the steps that you need to take to make a cash flow forecast:

• Estimate how much sales you expect to have
• Estimate when you expect to generate your sales
• Estimate how much costs you will incur 

Step 1: Estimate Sales

As a first step, you’ll need to estimate your likely sales for a given period of time (weekly, monthly, annual, or other).

To estimate how much sales you are likely to have, you may want to consider your historical sales records, consider any seasonal sales fluctuations, take into account any special events that are likely to impact your sales, and so on.

You can further refine your assessment by performing customer surveys, doing market research, or speaking to industry experts.

Step 2: Cash Collection Timeline

Once you have determined your likely sales, the next step is to see when you expect to actually receive your customer payments or actually receive money in your business accounts.

Most businesses pay their invoices anywhere between a net 30 to a net 60. 

There are instances where your account collection may be longer but you’ll need to consider how much you expect to collect, how much bad debt you may have, and how much money can eventually hit your bank account.

Step 3: Estimated Costs

Finally, once you have estimated your sales and have a good idea of when you will collect the money, your next step is to estimate how much money you will need to spend during the relevant period of time.

The costs that you are likely to incur may be a combination of fixed costs and variable costs, such as:

• Wages, salaries, and commissions 
• Raw material costs 
• Overhead costs
• Rent expenses 
• Marketing costs
• Research and development 
• Taxes 
• Ongoing business costs 

In the end, you can put together a forecast cash flow statement where you have a clear idea of following during your “forecasted” period:

• How much money you expect make
• When you expect to collect your money
• How much money you need to spend

Cash Forecast Takeaways 

So there you have it folks!

What does cash flow forecasting mean?

How does it work?

Cash flow forecasting refers to the process of “estimating” your company’s cash flows coming in and going out over a specific period of time.

Having a good understanding of your business’s cash flow is crucial to running a profitable business.

With cash forecasts, you can make better business decisions impacting your business cash flows, your cash management, and be ready to deal with cash flow ups and downs.

When you know that you have enough cash coming in, you’ll know how aggressively you can push new products into the market or how much money to pump into marketing your products and services.

Similarly, when you know that you will be hitting a seasonal downturn and expect to have less cash coming in, you can plan ahead and build yourself a cash contingency plan to be able to handle cash shortages for a period of time.

There are two main methods that you can use to build a cash flow forecast:

• Direct method
• Indirect method

The direct method is not as popular as the indirect method but allows to generate more accurate reports as you generate your estimates based on actual data.

The indirect method allows you to make forecasts using your net income and adding back items that affect profitability but do not impact cash like depreciation and amortization.

In the end, having a good cash flow forecast can make or break a business, allow you to make strategic decisions, decide which business projects to tackle, how much financing you need, which debt to pay off and so on.

I wish you good luck with your cash flow forecasting!

My Investing, Business, and Law Blog

By the way, on this blog, I focus on topics related to starting a business, business contracts, and investing, making money geared to beginners, entrepreneurs, business owners, or anyone eager to learn. 

Just so you know who I am and where I come from, a little about me…

I have a university degree in finance and law. 

I have worked in an international financial institution dealing with the stock market, stock, bonds, corporate financing, and securities.

I practiced law in private practice where I advised and consulted entrepreneurs and business owners on many aspects of their business, such as how to start new business ventures, how to scale their business, how to navigate commercial contracts, and how to set themselves up for success. 

I also acted as an in-house counsel and eventually as the General Counsel in a rapidly growing technology company going through hypergrowth, dealing with international Fortune 500 clients, and operating internationally. 

Let me tell you, in my career, I’ve learned a lot about business, investing, investment decisions, business decisions, and law. 

I started this blog out of my passion to share my knowledge with you in the areas of finance, investing, business, and law, topics that I truly love and have spent decades perfecting.

You may find useful nuggets of wisdom to help you in your entrepreneurship journey and as an investor.

I’d love to share the insider knowledge that I’ve acquired over the years helping you achieve your business and financial goals.

Now, let’s look at a summary of our findings.

Cash Forecasting Summary

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