Building a cash flow forecast is typically the responsibility of a company’s finance team. However, in order to forecast cash flow, input from multiple stakeholders and data sources is required, especially in large organizations.
What is Cash Flow Forecasting?
Forecasting cash flow is the act of predicting the inflow and outflow of money of a business over a specified time period. By anticipating future cash positions, avoiding crippling cash shortages, and maximizing returns on any cash surpluses they may have, companies benefit from an accurate cash flow forecast.
Why is Cash Flow Forecasting Accuracy Required?
It’s crucial for any firm (especially for unprofitable SaaS businesses investing to expand) to have a stable cash flow. Let’s examine the significance of having an accurate cash flow forecast.
1. Promote a Proactive Approach
An accurate cash flow forecast is crucial for understanding the consequences of the key decisions your company makes. It allows them to identify cash balance red flags like a negative balance and react before it’s too late. It also allows you to forecast short-term financing needs and plan when you need further investment.
An accurate view of your revenue and expense streams can help you identify problem areas and take the necessary corrective action. For example, if certain customers are slow to pay, you may be able to increase your collection efforts or shorten the payment terms in your contracts.
With accurate cash flow forecasting, businesses can have the answer to important questions like the following:
- How much can you spend on marketing and other business operations?
- Can you afford to hire more resources?
- Can you afford higher discounted prices?
2. Helps Understand Burn Rate
Having an accurate cash flow forecast gives you a better idea of how much runway you have at your current burn rate and what steps you need to take to be successful.
Especially at the startup or growth phase, when you know you cannot obtain further funding for another 12 months, but your cash will only last 10 months, you will have to find ways to reduce burn in order to extend your runway.
The other way around, knowing your business’s burn rate can help you anticipate whether you’ll need funding for your next round of investment. You can also use historical data on how long it takes to close an investment round to determine whether you’ll run out of money.
3. Keep Investors Comfortable
An accurate cash forecast and regular updates to investors/lenders increase trust and comfort, resulting in better investment or loan terms.
As discussed earlier, forecasting cash burn and knowing when the next investment round will occur is crucial. If you can convince investors/lenders that you can accurately forecast these things, their confidence in your management abilities will increase, and they will be more likely to invest in your company in the future.
4. Helps Prioritize Spendings
Accurately forecasting cash in situations where you have limited cash or a higher-than-expected burn rate allows you to prioritize which creditors to pay first. Conversely, if you perform poorly at forecasting cash, you may end up paying lower-priority creditors first. As a consequence, you might find yourself unable to pay a key creditor and have your funding cut off.
An accurate forecast also helps you prioritize payments to minimize interest while maintaining liquidity. For example, if you have a lot of cash and can repay your loan early, you’ll be able to do it as you’ll have enough money in the future.
5. Assists in Managing Working Capital
An accurate cash flow forecast will show you how much working capital impacts your cash position, so you can decide whether to concentrate on reducing it. Reducing your working capital will also lower your need for cash, allowing you to maintain a lower balance or delay future investment efforts.
5 Ways to Overcome Forecasting Cash Flow Challenges CPAs Face
Although cash flow forecasting is critical for a company’s working capital and financial health, it can be very difficult to perform. Here, we review some of the key issues with cash flow forecasting and offer practical solutions to address them.
1. Low Awareness Among Stakeholders
Because cash flow forecasting relies on the input of many individuals across an organization, it is heavily dependent on cash managers in the head office, financial controllers in business units and subsidiaries, and other individuals.
Because the reporting output relies on the knowledge of those contributing to the process, all personnel must accurately input data for each of the cash flows for which they are responsible. And the “rubbish in, rubbish out” problem can be avoided if time is spent educating or training the personnel involved in the process about knowledge gaps.
We have seen the following methods make a significant impact in improving the knowledge and awareness of the personnel involved in the process:
Historical Review
Prior to establishing a forecasting procedure, a comprehensive review of a company’s historical cash flows can offer a great deal of insight into critical cash flows such as customer payments and supplier payments. Recording and comprehending these flows may provide a strong foundation for future cash flow prediction.
Continuous Feedback
Users should be informed how accurate they have been after the update of real data flows, which should include a feedback mechanism. As new forecast versions are released, this feedback loop pushes for improvements in data quality.
2. Lack of Stakeholder’s Interest
When a process relies on input from subsidiaries, divisions, and other head office departments, ensuring that everyone remains engaged can be difficult. From an operational perspective, late or inaccurate forecast information is usually the result of late or inaccurate reporting deadlines.
However, forecasting cash flow can be achieved with the buy-in from key personnel. You can use the following strategies to increase the level of meaningful engagement with a forecasting process.
Top-Level Sponsorship
Senior management, such as the CFO or Finance Director sponsoring the cash flow forecasting process is critical to ensuring its efficient operation. Typically, the executive/board level will drive the forecasting process, but subsidiaries and process contributors should be aware of its importance.
Communicate Value to Contributors
Cash flow forecasting is sometimes perceived as a black hole for information at the business unit level. However, time is often wasted in compiling and reporting information, with the minimum value being gained. Finding ways to ensure that all participants gain value from forecasting has been shown to enhance its overall efficiency and effectiveness.
3. Manual Administration
Using spreadsheets to forecast cash flows across multiple business units and subsidiaries can be a time-consuming process, particularly when there is a lot of manual work involved.
This manual workload typically centers on consolidating spreadsheets that contain cash flow information, checking the final reporting output for errors, and troubleshooting problems such as intercompany mismatches.
The process may pose a significant administrative burden, but more importantly, the reporting output may be compromised by a lack of process control and audit capabilities, resulting in a large amount of manual intervention being required to produce the output.
Adopting online bookkeeping practice is the best way out of this cash flow forecasting challenge, and for this, you’ll need bookkeeping software.
If you have trouble finding the right bookkeeping software and migrating your system to an online system, you can even outsource your bookkeeping operation to experts like us.
4. Inability to Improve the Forecasting Model
Because most finance departments don’t have the time to manipulate data on spreadsheets to evaluate forecast accuracy, finance and bookkeeping systems that can perform variance analyses are cash forecasters’ best friends.
Using these software solutions, finance departments can compare forecasts to actual results over a specified time period and quickly identify any discrepancies. A feedback loop for improvements in forecast models is created by identifying the reason for any differences.
5. Technical Challenges
Technical components of forecasting may hamper high-quality forecasts in several ways. In some instances, these issues are industry-specific or firm-specific. Please feel free to contact us for advice on how to deal with these problems specifically.
In general sense, these challenges include the following:
Not Able to Link Long and Short-Term Forecasts
Organizations with big numbers keep two cash flow forecasts– one for short-term day-to-day planning (three months or less, split weekly) and one for long-term planning (12 months or more, split monthly). Because of their current procedures, linking the long- and short-term forecasts can be extremely challenging, creating a range of administration and reconciliation issues.
Intercompany Reconciliation
Forecasting the intercompany entity cash flows can be particularly challenging for businesses that engage in high-volume trading, such as manufacturing firms. In extreme cases, the issue can render the forecasting process useless. More commonly, it causes administration difficulties and requires significant reconciliations.
Don’t Ignore Cash Flow Projections
Cash flow is vital, no matter how large or small the company is; many business owners make cash flow mistakes but maintaining a close eye on cash flow and forecasts is crucial to a company’s financial health.
Hence, companies of every scale should make sure that cash flow and forecast are priorities for the company so that they can continue to operate smoothly and have sufficient capital to grow.
Cash flow should not be ignored when it comes to local business. For example, businesses such as restaurants should be forthcoming when it comes to managing cash flow.
