What Is Cash Flow Forecasting?

Understanding Cash Flow Forecasting

Cash flow forecasting, also known as cash forecasting, is the process of estimating how much cash will be leaving and coming into a business over a specific period. These forecasts are calculated based on the business’s expected income and expenses.

Cash flow forecasting can come with its share of challenges, since it can be difficult to predict future revenue and expenses with certainty. But it’s a critical part of financial planning for businesses of all sizes. When businesses understand how much cash they’re projected to have available, it helps them avoid shortages and plan adequately for their obligations.

Organizations will know, for example, if they need to cut costs, find additional financing, or increase sales efforts. Cash forecasting, then, is a critical component of risk management.

The Importance of Cash Flow Forecasting

Beyond helping with liquidity planning and financial stability, accurate cash flow forecasting also helps steer the business forward and allows for growth. With insights into their projected cash positions, companies can improve decision making around their investment strategy, spending, and financing.

Companies can use the insights from their cash forecasts to optimize working capital, too. They can get a better understanding of when they should optimally receive and issue payments, enhancing their accounts receivable and accounts payable processes. Additionally, accurate cash forecasts can help businesses optimize inventory levels if they have inventory on hand–not tying up too much money in excess product and ensuring there’s enough on hand to meet demand.

Types of Cash Flow Forecasting

Cash flow forecasts can be broken down into short-term and long-term. Short-term forecasts look at cash inflows and outflows over the course of the next year, peering into a company’s more immediate future. Because these types of forecasts project short term demands, they support more immediate actions and decisions for the business and help inform day-to-day operational decisions.

Common short-term forecasting intervals include 30-, 60-, and 90-day forecasts. Short term forecasts can keep the business more agile.

Long-term forecasts, on the other hand, look at 12 months and beyond and inform more far-future strategic planning. These projections also help companies formulate policies and procedures and more proactively manage their risk.

Generally speaking, cash flow forecasts become less accurate and reliable the further into the future the business is trying to project. It’s a good practice for businesses to combine insights from both short-term and long-term forecasting for the most complete picture.

How Cash Forecasting Works

Cash flow forecasting estimates future cash levels by incorporating some or all of the following inputs:

• Historical financial data
• The opening cash balance for the forecasting period
• Expected income (AR), sales forecasts, and other inflows (intercompany funding, dividends, 3^rd party inflows, etc.)
• Expected costs (AP) and scheduled outflows (operational expenses, capital expenditures, debt repayment, etc.)

When forecasting, certain businesses may also need to consider external market factors and economic conditions, such as inflation, interest rates, industry trends, global trade policies, and changing customer demand. If a business is more susceptible to these types of variables, they should regularly update their cash flow forecasts to account for them.

Common Cash Flow Forecasting Challenges

Businesses may run up against a host of issues as they compile their cash flow forecasts. For starters, many need to pull all their needed data from disparate systems and departments outside their own – which can be time-consuming and cause data to be inaccurate or out-of-date by the time they receive it.

Furthermore, it’s not uncommon to lack real-time visibility into the business’s global cash position. This can lead to poor forecasts, which can cause sub-optimal decision-making.

Forecasting can also be an incredibly inefficient process if businesses are doing it with spreadsheets and manual processes. This leads to errors and complications, and places a heavy burden on the treasury team, leaving them less time for analyzing the forecast and providing insights into the next best initiative for the business.

Unforeseen circumstances – spanning situations from government regulations to increased competition - can also throw a wrench into a company’s forecast and how it’s projecting to perform. Businesses need to regularly review the external environment and ensure they have enough cash buffer to stay ahead of the game.  

How Treasury Automation Enhances Cash Forecasting

Treasury automation solutions offer today’s businesses a way to accurately and quickly forecast their cash flow. These solutions integrate with a business’s entire banking structure – so to every bank and bank account – and to all their internal systems, such as their payment systems, ERP, and CRM. Further, real-time data flows automatically into one centralized place and then the system automatically calculates projected cash inflows and outflows, learning from historical data and trends in the system.

These cash flow forecasting tools can also help companies see how certain what-ifs might impact their cash flow projections by allowing users to create different cash flow scenarios. Artificial intelligence and machine learning often lend a hand in generating the cash flow forecasts out of these systems, which only enhance accuracy and reliability.

When businesses use automated cash flow forecasting tools, they benefit from:

• More Accurate Forecasts: Businesses can be more confident in their forecasts, seeing as they’re generated using real-time data from across the entire organization and use automatic calculations. This is preferable to the treasury team doing that work manually, which opens the door to human error and inaccuracies. Better forecasts mean more accurate and confident planning.
• Improved Forecasting Speed: Instead of taking hours or days to compile, forecasts can be generated with a few clicks. This allows businesses to see and respond to upcoming challenges more quickly.
• Better Cash Management: When businesses can accurately see what position they’re going to be in for a specific time period, they can ensure they’ll have the right liquidity levels to meet obligations and still take advantage of any opportunities that come their way.
• Reduced Risk: By seeing potential problems before they occur, businesses can take proactive steps to avoid shortages and maintain stability.
• Improved Financial Planning: Accurate cash flow forecasts inform budgeting and other financial planning activities, so having correct data at the start only improves the overall effectiveness of strategic planning initiatives.

There are many types of treasury automation solutions available. Businesses can opt to implement a robust Treasury Management System (TMS) or a more modular, cloud-based cash management solution instead. Businesses should take care to examine not only the cash flow forecasting capabilities of each solution, but also the cash visibility, reconciliation, compliance, and cash optimization components to understand which option is best for the organization.

Best Practices for Cash Flow Forecasting

A business can improve its cash flow forecasting processes by following a few best practices. First, they should use a combination of historical data and real-time data to create the most accurate forecast possible. Businesses should also keep their forecast regularly updated as new data becomes available, such as incorporating actual sales data (versus using just projected sales data) or inputting an updated receivables date if they learn a customer will be paying late.

It’s also a good idea to build collaboration between the teams that contribute to the forecast, such as AP, AR, Financial Planning & Analysis (FP&A), Sales, and Procurement. Having open communication channels can help each department understand its role in the forecast and encourage them to supply the required information in a timely manner to generate the forecast.

Lastly, to accurately and reliably generate cash flow forecasts, companies should take advantage of automation. This lets businesses collect and aggregate data more easily and forecast with greater precision.

As we’ve seen, cash flow forecasting not only helps inform a business’s day-to-day financial operations, but also its long-term decision-making. That said, it can be a process that takes a lot of time and effort. Modernizing that process with the right technology can significantly lower the burden on critical teams, and help businesses build their forecasts seamlessly without worrying about inaccurate or incomplete data.

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