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Cash Flow Forecast: How It Works and Why You Need It

Matthew Speiser

Staff Writer at Fundera
Matthew is a staff writer at Fundera. He has written extensively about ecommerce, marketing and sales, and payroll and HR solutions, but is particularly knowledgeable about merchant services. Matthew's writing has been published in Business Insider, The Fiscal Times, Best Company, and NJ.com, among others. Matthew was also a co-author for Startup Guide—a series of guidebooks designed to assist entrepreneurs in different cities around the world. He has a degree in journalism from the University of Delaware. Email: matthew.speiser@fundera.com.

Latest posts by Matthew Speiser (see all)

Editorial Note: Fundera exists to help you make better business decisions. That’s why we make sure our editorial integrity isn’t influenced by our own business. The opinions, analyses, reviews, or recommendations in this article are those of our editorial team alone.

Cash flow has always been king for small businesses. In fact, more small businesses fail because of cash flow problems than for any other reason.

It doesn’t have to be that way. There are many best practices, such as preparing a cash flow statement, that you can follow to help you manage cash flow and mitigate any problems. But to be truly useful, your cash flow forecast needs to be as accurate as possible. That’s a challenge, because any forecast involves an element of guess work. That being said, there are a number of things you can do to ensure that your cash flow forecast is as accurate and helpful as possible.

In this guide we are going to show you how to accurately cash flow forecast so that you can face cash flow issues head on and make responsible decisions on behalf of your business. But first, let’s learn a bit more about what cash flow is, and why it’s so important to prepare a cash flow forecast.

cash flow forecast

What Is Cash Flow?

Cash flow is the net amount of cash moving into and out of a business at any given time. The operative word here is “time,” as the amount of money moving in and out of your business can only really be understood through a given timeframe. Most businesses track their cash flow on a month-to-month basis.

When you have more money flowing into the business than you have flowing out, you are considered “cash flow positive.” It’s very important for a business to be cash flow positive, because then you have money in the bank to pay your employees, purchase inventory or raw materials, and cover all your other operating costs.

You can actually be profitable without having positive cash flow. If your business makes more money than it spends within a given year, you’re profitable. However, if you still have several outstanding invoices or you’re waiting for payments to process through a credit card company, you might have more cash flowing out of the business than you do coming in—in which case, you’re cash flow negative.

Being cash flow negative might mean you don’t have enough money to cover essential business expenses. However, if you create a cash flow forecast, you can avoid these types of situations by planning ahead.

What Is a Cash Flow Forecast?

A cash flow forecast is a model that estimates your business’s future financial position from a cash flow perspective in order to responsibly manage your finances in the present. When you make a cash flow forecast, you’re judging what your future cash flow will be based on anticipated payments, receivables, as well capital investment and debt financing.

Put another way, cash flow forecasting is a way to ensure that the business will have enough cash on hand to continue operating and avoid funding issues. It’s a core tenant of responsible business financial management.

Why You Need to Cash Flow Forecast

By now, we hope the importance of cash flow forecasting is obvious: It helps you manage your business finances responsibly. But why is that?

Well, say your business spends money on inventory. That money comes out of your business bank account but is booked as cost of goods sold. Once you sell the inventory, it is added to your profit and loss statement.

On the other hand, if your business makes a sale, that number is reflected in your profit and loss statement, but sits in accounts receivable until the customer pays. Your profit and loss and balance sheet create your cash flow statement, which you can then project forward to create a cash flow forecast.

In other words, a cash flow forecast reconciles the profit and loss with the balance sheet, and uses assumptions in each of these documents to project forward how much cash you’ll have on hand at any given point in time.

Businesses use cash flow forecasts for a variety of different financial planning purposes, including quarterly reports, interest and debt reduction, short term liquidity planning, and long term budgeting.

Cash Flow Forecast Methods

There are two different methods of cash flow forecasting: direct and indirect.

  • Direct is typically used for short-term cash flow forecasting (90 days or less) and factors in estimated receipts from accounts payable and accounts receivable. Direct cash flow forecasts are usually fairly accurate, given that you are relying more on hard data.
  • Indirect cash flow forecasting is for longer term financial planning and relies on projected balance sheets and income statements. Indirect cash flow forecasts have a greater likelihood of being inaccurate, given that you are relying on projected business activity.

How to Make a Cash Flow Forecast

To create a cash flow forecast, you’ll actually want to create forecasts for sales and profit and loss first, as this will help you build a better understanding of your cash flow forecast. Let’s break this down into a step-by-step process:

Create a Sales Forecast

A sales forecast is a projection of how much you expect to sell in the future, typically broken down month by month. Your sales forecast should factor in your previous year’s sales figures, any new products you might sell, your ideal sales mix, and any news business you are hoping to win.

Create a Profit and Loss Forecast

Once you have your sales forecast, you can use it to establish a profit and loss forecast. This forecast will combine your business’s income with the day-to-day expenses of running the business. Costs that should be factored into the profit and loss forecast include raw materials or inventory, staff wages, third-party services like payroll software or freelancer contracts, and general operating expenses like rent and electricity.

Keep in mind that you need to list costs on your profit and loss forecast in the month that you incur them, so as to keep your forecast accurate.

Create Your Cash Flow Forecast

With your sales and profit and loss forecasts in hand, you’re now ready to create your cash flow forecast.

To start, use your sales forecast to estimate how much money you expect to come in, taking special care to be as accurate as possible about the dates when the money will actually become available. If you plan on getting a cash injection from a loan, also be sure to list that on your cash flow forecast (but not on your sales forecast).

Next, subtract the costs from your profit and loss statement, making sure to include the costs in the months you plan to pay them. Also add anticipated one-off payments to your cash flow forecast, such as equipment and taxes.

Then add up all the money spent each month, and subtract it from the money coming in to get your net cash flow.

Finally, apply this number as if it were your bank balance at the end of the previous month. Then look at your bank balance at the end of the current month. If your bank balance is decreasing month to month, you might need to take out a business loan to remain cash flow positive. If it’s rising, perhaps it’s time to reinvest some of that money into your business.

cash flow forecast

Tips for Creating an Accurate Cash Flow Forecast

The key to a successful cash flow projection is to make it accurate. After all, you don’t want to be making strategic investments and decisions assuming an inaccurate cash flow forecast.

How can you make sure your cash flow forecast is accurate?

Here are five key tips.

1. Analyze Business Indicators

As you prepare and maintain your cash flow forecast, you’ll need to keep an eye on your business indicators, such as your sales pipeline. Are there any big deals lining up that could have a positive effect on cash flow? Is any investment needed to make those deals happen, like marketing, product development, staff, or travel? What about your sales funnel? Is any cash outlay needed to close the opportunities at various stages of the funnel? This insight will inform your forecast for the months ahead.

2. Estimate Your Sales Bookings Timeline

Now that you’ve studied your pipeline, it’s time to assess when these opportunities will close and generate cash.

Forecast out on a weekly or monthly basis and build this into your cash flow forecast—remembering, of course, that a closed deal doesn’t mean cash in hand. It might take weeks, or even months, for your client to pay for your products or services. This exercise will give you some assumptions to play with.

3. Wrap Your Arms Around Your Budget

Your cash flow forecast should account for any anticipated expenses and their payment dates. This is where your business budget document can help… if it’s maintained regularly. Be sure to include all your obligations, including both fixed and variable costs, and make sure they’re up to date!

4. Be a Diligent Collector

Because of their light management and administrative structures, small businesses can find collections a challenge. But slow-paying or late-paying clients are a primary cause of cash flow problems. Even if business is booming and profits are high, a late-paying client can wreak havoc on your cash flow situation.

The solution? Work on being a diligent collector. Use your contract terms to help you establish some form of forecast accuracy as to when cash will hit the bank, and restate those terms on your invoice.

Another way to take the guesswork out of your cash flow forecast is to introduce some predictability into the payment process by making it easier and quicker for your clients to pay you. It could be via PayPal, credit card, electronic funds transfer, or epayment services like Bill.com or Plooto.

5. Maintain Your Forecast

Your cash flow forecast is a living, breathing document. Get into the habit of regularly reviewing all of the above and updating your forecast accordingly. You can also use your cash flow statement (different from your cash flow forecast) to help you review how you’re doing against your forecast.

This can help you spot patterns and trends, like how quickly or slowly a certain client pays you, and ensure a more accurate forecast for the months ahead.

Manage Business Finances Responsibly With a Cash Flow Forecast

By maintaining a cash flow forecast, you’re getting a significantly more accurate read on the financial health of your business. Furthermore, you’ll be prepared for times when money might be tight, and identify certain patterns in your cash flow fluctuations. Perhaps most important,  with a cash flow forecast you’ll be able to relieve the anxieties of the unknown and sleep more easily knowing that you’re prepared for what’s to come.

Matthew Speiser

Staff Writer at Fundera
Matthew is a staff writer at Fundera. He has written extensively about ecommerce, marketing and sales, and payroll and HR solutions, but is particularly knowledgeable about merchant services. Matthew's writing has been published in Business Insider, The Fiscal Times, Best Company, and NJ.com, among others. Matthew was also a co-author for Startup Guide—a series of guidebooks designed to assist entrepreneurs in different cities around the world. He has a degree in journalism from the University of Delaware. Email: matthew.speiser@fundera.com.

Latest posts by Matthew Speiser (see all)

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