Cash flow forecasting is the process of obtaining an estimate of a company's future cash levels, and its financial position more broadly.[1] A cash flow forecast is a key financial management tool, both for large corporates, and for smaller entrepreneurial businesses. The forecast is typically based on anticipated payments and receivables. Several forecasting methodologies are available.
Function
Cash flow forecasting is an element of financial management. Maintaining a company's cash flow is a central part of managing the business and the financing of ongoing operations — particularly for start-ups and small enterprises. If the business runs out of funds and is not able to obtain new finance, it will become insolvent, and be forced to declare bankruptcy.
Cash flow forecasting helps managements forecast cash levels to avoid insolvency. The frequency of forecasting is determined by several factors, such as characteristics of the business, the industry, and regulatory requirements.[2] In a stressed situation, where insolvency is near, forecasting may be needed on a daily basis.
Key items and aspects of cash flow forecasting:
- Identifying potential shortfalls in cash balances in advance.
- Making sure that the business can afford to pay suppliers and employees.
- Spotting problems with customer payments.
- As a discipline of financial planning — the cash flow forecast is a management process
Corporate finance
In the context of corporate finance, cash flow forecasting is the modeling of a company or entity's future financial liquidity over a specific timeframe: short term generally relates to working capital management, and longer term to asset and liability management.
Cash typically refers to the company's total bank balances, but often what is forecast is the treasury position, which is cash plus short-term investments minus short-term debt. Cash flow is the change in cash or treasury position from one period to the next period. The cash flow projection is an important input into valuation of assets, budgeting and determining appropriate capital structures in LBOs and leveraged recapitalizations. Depending on the organization, then, this modeling may sit with "FP&A" or with corporate treasury.
Methods
Cash flows may be forecast directly, alongside several indirect methods.
The direct method of cash flow
Entrepreneurial
In the context of entrepreneurs or managers of small and medium enterprises, cash flow forecasting may be somewhat simpler, planning what cash will come into the business or business unit in order to ensure that outgoing can be managed so as to avoid them exceeding cashflow coming in. Entrepreneurs will be aware that "Cash is king" and, therefore, invest time and effort in cashflow forecasting.
Methods
A common approach here is to build a spreadsheet, typically in Excel, showing cash coming in from all sources out to at least 90 days, and all cash going out for the same period; any shortfall or mismatch can then be addressed, with e.g. a bridge loan or via increased collections activity. For short term cash flow forecasting there are also a number of AI driven low cost software applications available.
Applying the "spreadsheet approach" requires that the quantity and timings of receipts of cash from sales are reasonably accurate, which in turn requires judgement honed by experience of the industry concerned, because it is rare for cash receipts to match sales forecasts exactly, and it is also rare for customers all to pay on time. (These principles remain constant whether the cash flow forecasting is done on a spreadsheet or on paper or on some other IT system.) correspondingly, it is noted that when using theoretical methods in cash flow forecasting for managing a business - i.e. using financial accounting as opposed to management accounting standards - non-cash items may be included in the cashflow, skewing the result.
See also
- Cash-flow diagram
- Cash flow at risk
- Cash is king
- Financial forecast
- Forecast period (finance)
- Mid-year adjustment
- Owner earnings
- Operating budget
References
- Martin Gillespie (2016), What is Cash Flow Forecasting?, cashanalytics.com, accessed 16 November 2023^
- Should I do Monthly, Weekly or Daily Cash Flow Forecasting? simplycashflow.com, retrieved 2013-05-27^
- Tony de Caux, "Cash Forecasting", Treasurer's Companion, Association of Corporate Treasurers, 2005^