Good decisions typically rely on good information, and good information can come from forecasting cash flow.
Let's imagine you're trying to decide if you can afford to hire a new employee…say a new sales rep. You could take a deep breath, jump and decide to bring on a great new member of your team. You could leave it to chance and assume everything will work out just fine.
Or you could make a solid decision based on forecasting cash flow.
What Is a Cash-Flow Forecast?
Exactly what it sounds like. Forecasting cash flow lets you know what's coming into your business bank account and what's going out over a period of time. Typically, cash-flow forecasts cover twelve months, though depending on your needs, you can cover a shorter or longer period of time.
A cash-flow forecast begins with a starting account balance. You add the money that you expect to come in to that balance. You may see these funds referred to as sales, revenue, inflow or receipts, but those terms are—for most purposes—interchangeable.
You subtract from that balance the money you know will go out of the business. These funds may be called expenses, payments or outflow…again, largely interchangeable. You'll have the difference between your cash inflow and outflow, expressed as either a positive (yay!) or a negative (boo!) number.
Forecasting cash flow can be as detailed or as general as you need for your particular purposes. For example, you might want to trace one particular source of inflow over time and compare it to previous years.
In that case, it would make sense to break out your biggest client, your sales by state, your sales from your website or your B2B revenue in order to gain a little more insight. Likewise, if one of your expenses varies seasonally, it might make sense to break that expense out for easier tracking.
How Do I Go About Forecasting Cash Flow?
For a brand new business, I'm not gonna lie to you: It isn't easy when you're starting from scratch. Your best bet is to ballpark sales and expenses and revisit them when you have real numbers after a month or two.
But for an established business, you can look at historical revenue figures and estimate sales over the next year. Same thing for expenses. Figure out what you know you're going to spend based on your previous years.
One thing to remember when forecasting cash flow: You count inflow funds for the period they're received, not the period they're invoiced. This is important! Depending on your terms, you may have some clients who pay on the spot, while others may be 30, 60 or even 90 days out. Invoices aren't cash. Wait until you see the cash (or can expect to see the cash) to count it into your cash flow.
The same situation applies for expenses: Quarterly payments shouldn't be averaged out and counted in every month when you're forecasting cash flow. You want to understand how that quarterly payment affects your cash flow. You might need additional cash coming in four times a year to manage a quarterly payment.
Why Should I Forecast My Cash Flow?
Now on to the good stuff! Why does forecasting cash flow even matter? After all, you probably already have more accounting reports than you actually care to use. A cash-flow forecast can be a powerful tool that helps guide your business decisions.
Forecasting cash flow can help you identify probable shortfalls or surpluses. If your forecast indicates you're going to be unable to meet all your obligations, it might be time to shake things up and generate new sales.
Cash-flow forecasts can also help you get a handle on and prepare for seasonal fluctuations. That forecast may tell you that while you may feel flush in December, lean times are ahead in January. You can plan better if you know what's coming.
The applications and uses of a cash-flow forecast are everywhere. Remember that hypothetical salesperson you were considering hiring? Forecasting cash flow lets you add that salary to your cash flow forecast, along with projected increases in sales, to determine if you can afford a new hire.
Having a good handle on what's ahead in terms of cash flow lets you make better decisions with better information.
Read more articles on critical numbers.