An accountant sitting on the moon looking at a cash forecast in the sky

1-2-3 Simple Cash Forecasting

Accounting is not just recording the past, it is determining the future. Company’s should be aware of how much cash they will need to operate while making investments. The best way to do that is with cash forecasting. A forecast can work as a guide for hiring employees, major cash events, or growth in the coming years. 

In this article:

  • What is cash forecasting?
  • Direct vs indirect cash flow forecasts
  • How to do a simple cash flow forecast
  • What is variance analysis?
  • 5 tips to get an accurate cash forecast

What Is Cash Forecasting?

A cash forecast is a projection of future cashflow, based on expected revenue and expenses. It considers all the ways a company generates cash, not just main revenue streams. It is an estimate of cash inflows and outflows for any given period.

Quick Definition 

Liquidity: how quickly a company’s assets can be converted to cash aka liquid assets.

Much can be anticipated with a forecast, but the main goal is to manage liquidity. Forecasts are a proactive way to predict cash shortages and avoid loss. Over time they allow a business to assess its performance and expand profit margins.

A Cash Forecast vs Projection

A forecast and a projection are not the same. A cash flow forecast is a statement that focuses on the company’s expected cash position. These numbers are built on past activity that is highly likely to repeat. A cash forecast relies on accurate accounting and reporting on industry patterns. 

A financial projection is like a what-if scenario. It is dissecting a business goal, from multiple vantage points, involving many possible factors. Think of it as a company agenda for sales and marketing. A financial projection uses historical statements to build from but is less accurate because expenses aren’t considered.

Cash Flow Planning vs Cash Forecasting

A cash forecast is a cash balance you would like to achieve, cash flow planning is how you get there. You can estimate cash flow based on past trends, but that means your business needs to perform at the same output. How do you do that? By following a careful cash plan to balance your expenses and meet expected results. 

An accountant running from a cash crunch wallet monster eating all the money flying from his pocket

Top 5 Reasons To Do A Cash Flow Forecast

The way you run your business will affect your cash flow needs. For example: If you are a seasonal business you need to be doing cash forecasting, so you don’t find yourself in a cash crunch during downtime. Here are the top 5 reasons to do a cash flow forecast.

  1. Debt planning and management
  2. Budgeting for the next fiscal year  
  3. Predict short term cash flow 
  4. Entice investors
  5. Planning for business growth via hiring new employees

Cash Forecasting: Direct vs Indirect Method

Forecasting is not one size fits all. Like cash flow statements, the typical cash forecasting process runs on two methods: Direct Method and Indirect Method. In general, most companies use the direct method cash forecasting

The direct method cash forecast scrutinizes all areas of operations. You look back at cash flow statements for the same amount of time you are forecasting. They are simple to do and good for short-term or medium-term predictions. They generally cover anywhere from daily management to one year ahead. These cash forecasts are commonly used by management to understand cash surpluses after expenses.

Accountants pouring money into businesses via direct method cash forecasting

Indirect method forecasting is implemented for longer terms, more than a year. This type of forecasting is reserved for larger companies, experiencing significant changes to cashflow. They tend to be far more inaccurate because the business activity is harder to control.

The success of an indirect cash forecast depends on the complexity of the company. Companies spread out over multiple countries will have specific obstacles like currency exchange rates, tax due dates, and data systems.

How To Forecast Cash Flow

What is your overarching goal for money management? This will dictate how you approach your forecast, and where you want to concentrate your cash. Our simple cash flow forecast, will help you to visualize your monthly cash needs. To begin, what are you setting out to do with this forecast…?

  • Analyzing an increase or decrease in revenue and/or COGS?
  • Buying or selling assets?
  • Managing a loan?
  • Estimating payroll costs or changes in staffing?
  • Judging the impact of cash investments, mergers, or acquisitions?

How To Do A Direct Method Cash Flow Forecast

To ease your forecasting process, here is a simple cash flow forecast for any business. We will provide an example business scenario, to show how it works. Gather all sources of cash flow and follow along. Don’t leave out any expenses. Have a good idea of what your major and minor costs of business are: 

  • Fixed costs (payroll, rent, utilities)
  • Variable costs (COGS, quarterly taxes, seasonal inventory, months with extra pay periods)
  • Upcoming one-time expenses (equipment, vehicles)

We like to measure by month and have arranged ours into 3 months to reflect the quarter. You can extend this forecast for up to 12 months. Add in all your sources of incoming and outgoing cash. Note: Your beginning cash balance will always be your closing cash balance of the previous month.

simple cash flow forecast spreadsheet download

Cash Flow Forecast Example

An eCommerce store has a beginning cash balance of $10,000. They have two main sources of cash inflows: monthly sales of $4000 and affiliate marketing bringing in $1500/month. Based on last year’s sales, and the last 3 months, they expect sales to increase by 5% each month. Payroll is $2200/month for 2 contractors. They have a big inventory shipment coming up in June, for $6000. Shipping materials and warehouse fees cost $500/month. Total office expenses are $250 for marketing, systems, etc. 

cash flow forecast spreadsheet example

Striving For Accuracy In Cash Forecasting

Predicting the exact future in granular detail, is hard—ask a fortune teller. There is an acceptable degree of guesswork in forecasting. This lack of accuracy shouldn’t be discouraging though. These predictions get more accurate in time, especially when a business is actively managing liquidity with continuous cash forecasting. Here is how to use variance analysis to increase accuracy for a cash flow forecast:

What Is Variance Analysis?

Calculating variance analysis is a tool to determine the validity of a cash forecast. This is a comparison between the forecast and what actually happened. The variance formula is expressed as a percentage, dollar amount, or number of units. Note: When you have a positive number you have outperformance; a negative number you have underperformance. Below is how to calculate variance:

Variance Percentage Formula Example for cash flow forecasting analysis

Percentage Variance Formula

This measures the percentage difference between your estimated balance and actual. 

Variance % = (Actual Revenue/Forecast Revenue) – 1

For Example: A company had a revenue forecast of $85,000 and the actual revenue earned is $100,000

Variance % = ($100,000/$85,000) – 1

Variance % = 1.176 – 1 = .176

Then you express the final number as a percentage. So this company outperformed their forecast by 17.6%

Variance Dollar Formula for cash forecasting analysis

Dollar Variance Formula

This formula measures dollars or units, showing the literal number difference between a forecast balance and the actual balance.   

Variance $ = Actual – Forecast

For Example: A company had a revenue forecast of $110,000 and the actual revenue earned is $90,000. 

Variance $ = $90,000 – $110,000

Variance $ = -$20,000

This company underperformed its forecast by $20,000

Insights From A Cash Flow Forecast

As stated before a cash forecast can help you measure progress in the business. Here are some key insights to gain from a cash forecast analysis:

  • Able to see if a client is continually paying on time
  • If a supplier is reliable in relation to your company’s product sales
  • Accurately measure the cost of growth
  • Realize the patterns of sales and your cash flow cycle to better time the highs and lows
  • Avoid defaulting on loans or a cash crunch period
  • Qualitative analysis of investments or business decisions

Quick Definitions

Positive Cash Flow: more cash coming in than going out.

Negative Cash Flow: more cash going out than coming in.

Cash Crunch: there is not enough cash to meet operational needs.

Inaccurate Cash Flow Forecasts

It is rare to come out with a perfect forecast, they are merely financial guides. A certain ebb and flow of cash should be maintained for real-life situations in business. Missing your predictions shouldn’t be alarming unless you are consistently getting wide variations

Here are 5 tips to make a cash forecast more accurate:

  1. For startups, there is less history to base a forecast on. Keep up short-term forecasts and measure your variance. Your predictions will become better over time. 
  2. Cash forecasts for small businesses should run early and often. Be proactive about cash management, to avoid a cash crunch. If you run a forecast to fix insolvency, it may be too late and accuracy will be useless. 
  3. Communicate financial goals to the team. The success of meeting cash flow forecasting goals requires the participation and engagement of everyone at the company. The company may have acted in a manner that contradicted the forecast, out of necessity or lack of resources. 
  4. Be creative about driving other lines of cash flow versus focusing only on sales. Accuracy is achieved with a holistic business approach to meeting the forecasted balance.
  5. Adhere to key performance indicators (KPI’s) of your cash flow cycle. This will help you estimate a more accurate net cash flow for each month.

Cash Flow Cycle Key Performance Indicators (KPI)

Days Sales Outstanding (DSO’s): the average number of days sales are in receivables, predicting the sales/day. For Example: If you give a client 30 days to pay but have a late window of 15 days, that is an average DSO of 45 days.

Days Payments Outstanding (DPO’s): the average number of days bills are paid in accounts payable. For Example: If you have vendor bills that are paid within 15 days that is an average DPO of 15 days.

Accountants trying to hit a moving target with darts like cash forecasting

It’s A Moving Target

Cash forecasting is not known for accuracy. You want to get as close to the number as possible. Think of it like shooting a moving target—just try to get close to the center. This will help you anticipate major expenses and arrive at expected cash balances. With everything in accounting, your cash flow planning and forecasting requires accurate bookkeeping. If you are getting wildly inaccurate cash balance predictions, consider hiring a professional to help pinpoint areas of improvement.

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