How to Forecast Cash Flow and Reduce Uncertainty

Accurately forecasting your company’s cash flow requires a bit of work. Better cash flow forecasting can help you purchase, plan and invest over time.

Jack Welch, General Electric’s CEO from 1981–2001, may have said it best: “If I had to run a company on three measures, those measures would be customer satisfaction, employee satisfaction and cash flow.”

Under Welch’s leadership, GE’s market cap grew from $12B to more than $400B and achieved its highest-ever stock price — so it’s safe to say he knew a thing or two about the importance of cash flow.

Cash flow is a measure of the money going in and out of your business. Cash flow forecasting predicts cash inflows and outflows over a prescribed period of days, weeks, months or quarters. This has several benefits, allowing your business to:

• Predict money shortages so you can make more proactive and informed financial decisions.

• Make bill and debt payments on time.

• Plan growth strategies effectively and maximize the value of your cash surpluses.

• Maintain a good reputation with suppliers, team members, investors and other stakeholders relying on your cash flow.

An accurate forecast is crucial for any business, including small and mid-sized businesses. Even when sales are high, you could be at risk of cash shortages if payments are delayed in accounts receivable.

It can be challenging to accurately forecast your cash flow, especially if you don’t have much accounting or finance experience. Fortunately, creating a reliable cash flow forecast is accessible with a combination of realistic expectations and the right tools and data.

How can you forecast your cash flow to reduce uncertainty and plan ahead for your small or mid-sized business?

Determine your cash flow forecasting period

Before you start, you’ll need to choose a period of time to forecast. This will depend on your goal. Are you looking to cover day-to-day business obligations, manage loan payments or plan for long-term growth?

Most businesses create monthly or quarterly forecasts for short-term planning, debt repayment and risk management. Long-term forecasts, which typically span six to 12 months, are more useful for growth strategies. One thing to consider when choosing your forecasting period is accuracy: the longer the period, the less accurate your cash flow forecast is likely to be.

If you’re unsure how to approach your cash flow forecast based on your goals, you might want to consider consulting your CFO, lead financial person or an external accountant.

Gather your financial information and tools for cash flow forecasting

Start by gathering recent profit and loss statements. The financial data you’ll need is likely available in your bank account information, accounts payable, accounts receivable or accounting software.

Use this as an opportunity to review your financial information for high-level trends over the last few months to a year. This will illuminate any patterns — such as whether your profit or loss fluctuates based on the time of year — which will help you create a more realistic and accurate forecast.

You might also want to consider other factors that can influence forecasting. For example:

• How your business receives income, whether it’s point-of-sale collections or recurring revenue streams.

• How and when your best customers make payments.

• What forms of financing your company uses to generate cash flow and how often you use them.

• Whether your business or industry is prone to known or surprise events that could create intense or sudden cash demands.

• Whether there’s a sell-through cycle that stretches from inventory acquisition to collections.

Make sure you have your opening bank balance, which is your current cash on hand. You’ll also need a tool to create your forecast. This could be Quicken, QuickBooks, industry-specific software, an online calculator or a spreadsheet program like Microsoft Excel.

Creating an upcoming revenue and expense schedule helps you plan for the months ahead.

Many programs provide a “digital checkbook” format where expenses and revenues are entered to render an ongoing balance, also known as the “cash position.” In a spreadsheet, you can use columns to record revenue and expense items, and rows for days, weeks or months, depending on what works for your forecasting period. Note that Excel requires manual entry and formula management, whereas some tools apply these automatically.

Before proceeding, remember that the goal is to create an upcoming revenue and expense schedule to help you meet obligations and plan for the months ahead. Your cash flow forecast should be flexible, allowing for daily, weekly or monthly updates as often as new financial information is available.

Use your profit and loss data to build a cash flow forecast

Because expenses are almost always more predictable than sales or collections, start building your forecast by entering known and recurring expenses. This includes items such as rent, payroll, benefits, utilities and loan payments for the current month or future months. Then, enter periodic or variable expenses such as planned inventory purchases, supplies, insurance premiums or tax estimates.

Once you document and know your metrics, you can focus on where you need to make improvements.

Next comes the hard part: scheduling anticipated revenues or collections. Consider when the cash is likely to show up in your account. Enter known deposits, prepayments or anticipated subscription revenue and include point-of-sale revenue for any expected retail sales.

Finally, starting with your opening bank balance, subtract your net loss from your net income for each daily, weekly or monthly column. This will show you whether your cash flow is positive or negative over your forecasting period.

There are some other metrics you can use to calculate anticipated revenue. For example, consider including:

• Average monthly collections.

• Collections as a percentage of all receivables.

• Collections as a percentage of aging, which shows how many outstanding invoices you have by date range (1–30, 31–60 or 61–90 days).

• Days sales outstanding (DSO), which indicates the number of days needed to convert sales to cash.

• Free cash flow, which indicates your company’s ability to meet upcoming expenses.

Allocate these items into your forecast by day, week or month, and then adjust as collections occur or bills are paid. Keep in mind that you can improve these metrics. For example, a leading logistics company did this by using early payments to strengthen its balance sheet.

Review your cash flow forecasts

One of the most important steps you can take to reduce cash flow uncertainty is to periodically review the accuracy of your forecast. As the forecasting period progresses or ends, check actual numbers against what you predicted. Note anything you missed accounting for and take the time to understand why your forecast fell short.

This step will help inform your ongoing business decisions. For example, how many new team members can you realistically afford to hire next quarter if your expenses were higher than you anticipated last quarter?

The payoff

For many business owners, a more unpredictable business climate means a stronger need for financial certainty. Maintaining an accurate cash flow forecast will help you better prepare for cash shortages, grow your business effectively over time and keep your stakeholders happy. With a high-quality cash flow forecast in hand, you just might find yourself worrying less about your business — and sleeping more at night.

Learn how C2FO can help you take control of your cash flow.

Original article published March 5, 2021. Updated July 15, 2022.