A young woman in an orange sweater is smiling in front of a window. curve

What is Cash Flow Forecasting: Guide to Accurate Cash Flow Forecasting

We’ve paired this article with a comprehensive guide to accounts payable. Get your copy of the Accounts Payable Survival Guide!

Preparing and using an accurate cash flow forecast is essential for financial management and small business owners to use in planning, decision-making, financing, and cash management. 

What is Cash Flow Forecasting?

Cash flow forecasting shows you if your business has enough cash to run normal operations and/or expand business by estimating the cash effect and timing of your future sales and costs. A cash flow forecast is a critical tool for projecting your company’s financial health, helping you budget, invest cash surpluses, and time financing needed for cash shortages and repayments.

What is Cash Flow Forecasting Used For?

Cash Flow Management

Cash flow forecasting predicts the timing and amount of cash inflows, cash outflows and projected cash balances. A cash flow forecast is used as a planning tool prompting companies to analyze and make changes in spending to improve cash flow when combined with spend analysis and budgeting. 

Besides cash forecasting, for cash management businesses:

  • Institute cash controls (including controls over vendor master files to reduce fraudulent payments)
  • Expedite receivables collections
  • Take early payment discounts on vendor invoices in accounts payable
  • Obtain financing, and
  • Use a business credit line for better cash flow management.  

Business Plans

A cash flow forecast is included in business plans for the company’s use and shared with potential investors to raise venture capital. 

Cash Flow Statement

The cash flow statement presents actual cash flows and forecasts a company’s future cash flows.  

A cash flow statement is a type of financial statement required for GAAP compliance, besides the income statement and balance sheet. Accounting standards let businesses use either the indirect method or the direct method for the cash flow statement. 

An indirect cash flow statement shows the cash flow from operating activities beginning with net income (loss), changes in working capital balances by account type and add-backs for non-cash expenses, and net cash flows from operating activities. 

The operating activities section is followed by cash flow line items and net cash flow totals in the investing activities section and financing activities section. 

The indirect cash flow statement then shows total net cash flow, beginning cash and cash equivalents balance, and ending cash and cash equivalents balance, followed by GAAP disclosures that must be shown on the cash flow statement.  

The beginning and ending cash and cash equivalent balances are from the cash position and cash equivalents on the balance sheet for each date, which is equal to the total of bank account balances and marketable securities or other types of cash equivalents. 

The direct method shows beginning cash and cash equivalents balance, cash inflows and cash outflows by line item type, classified as operating, financing, and investing activities, and ending cash and cash equivalents balance. 

Business Opportunity and Project Evaluations using Cash Flow Projections

Cash flow forecasting related to an opportunity is used to make business decisions about potential projects evaluated using financial analysis methods like net present value (NPV) and internal rate of return (IRR)

What is Cash Flow?

Cash flow isn’t the same as profitability or net income (loss). Cash is tied up in working capital and converted back to cash in the cash-to-cash cycle. Non-cash expenses like depreciation and credit loss reserves impact profitability, but not cash flow. 

Net working capital is the total of short-term or current assets, less current liabilities. Current assets include cash and cash equivalents like marketable securities, accounts receivable, inventory, and pre-paid assets. Current liabilities include accounts payable, accrued liabilities, and the short-term portion of debt. 

Cash Forecasting Methods

Usually, businesses use one of three (or a combination of) methods to forecast short-term cash flow:

  • Receipts and disbursements (or working capital approach)
  • Bank data approach
  • Business intelligence (or statistical modeling approach)

How can your business improve cash flow forecasting?

Download our eBook, “The Holy Grail of Accounts Payable,” to learn how AP automation can help in cash flow forecasting.

What is the Cash Flow Forecast Formula?

The cash flow forecast formula is a simple formula for adding projected cash inflows and subtracting projected cash outflows to the beginning cash balance to estimate the ending cash balance for the cash forecasting period. 

Cash Flow Forecast Formula: 

Beginning Cash Balance + Projected Cash Inflows - Projected Cash Outflows = Ending Cash Balance

How to Forecast Cash Flow 

To forecast future cash flows for a business, use your cash flow forecasting software or an Excel cash flow forecast template to create a cash flow forecasting model. 

If you use an Excel model for cash forecasting, review the spreadsheet to ensure that your cash flow formulas and assumptions are correct. Document your model assumptions. 

Cash forecasting software integrates with your ERP system or accounting software, lets you access real-time cash forecasts compared to budgets, produces timely and accurate cash forecasting automation, and may include an audit trail.  

Note that government entities use a different accounting method and cash flow forecasting model. For forecasting of cash flow, consider using a cash flow forecasting Excel template designed for government use instead.
Steps in the business cash forecasting process are:

  1. Choose a series of time periods to use for the cash flow forecast.

    Generally, cash flow forecasts are prepared for either a three-year or five-year time period. Year one shows monthly time periods, and subsequent years may include quarterly or yearly periods. 

  2. Enter the beginning cash or the cash and cash equivalents balance.

    The beginning cash balance equals the fiscal or calendar year-end amount of cash or cash and cash equivalents on the balance sheet. 

  3. Forecast revenues by type using sales department projections and expected growth rates. 

    Forecast sales and service revenues by type. Use the sales team’s input for better estimates of expected growth rates or actual amounts to enter into the cash forecast. 

  4. Apply trade receivables cash collection time or percentages for estimating cash receipts.

    Compute the percentage of cash and credit card sales (less payment processing fees) vs sales on account for which credit is extended to customers. Your business receives cash immediately for cash and credit card sales. The accounts receivable aging report shows days outstanding since invoice date in time ranges by customer and in total and the percentage in each time range. Use the average percentage of early payment discounts taken in your business to reduce the cash proceeds amount expected from receivables collection. Know the credit loss rate of your business to estimate uncollectible trade accounts receivable write-offs. 

  5. Budget cash expenditures, including fixed assets, by category for each time period.

    Your company budget details cash expenditures, including business expenses, inventory purchases, and capital expenditures by type. 

  6. Use days payable outstanding (DPO) time metrics or percentages for estimating disbursements.

    Know the percentage of immediate cash payments for spending. For purchases included in accounts payable, know your company’s accounts payable turnover ratio or days payable outstanding metrics to estimate the reasonable periods for cash disbursements through AP payments in your cash flow forecast. 

  7. Calculate the ending cash balance.

    The ending cash balance or cash and cash equivalents balance is an automatically calculated estimate from the cash flow forecast. 

  8. Indicate financing required by type for each time period to cover shortfalls.

    Sometimes cash balances are less than required for expenditures in the period. Indicate the use of financing to fill the cash shortfall gaps. Plan to draw down an existing business line of credit, contact lenders, or raise capital when more financing is needed. 

  9. Automatically recalculate the ending cash balance for each time horizon. 

    The ending cash balance or cash and cash equivalents balance is an automatically calculated estimate from the cash flow forecast after adjusting for any financing required. 

Why is Cash Flow Forecasting Important?

Whether a business is growing quickly or missing its financial projections, cash flow and financing must be sufficient to meet its short-term obligations as needed. Companies with liquidity during the next twelve months can continue operating as a going concern, avoiding bankruptcy and going-concern GAAP disclosures that negatively impact stock price and valuation. 

Preparing cash flow forecasts in combination with financial analysis formulas like Z-score and liquidity ratios gives a business heads up regarding any liquidity issues and allows it to change. A company can reduce expenses, obtain financing when possible, or consider selling the company through M&A to prevent insufficient cash flow.

CFOs, treasury management, and FP&A financial analysts at companies use cash flow projections showing time-adjusted inflows and outflows in net present value and IRR analysis. This type of investment analysis for business decisions evaluates whether to initiate a significant new project or business opportunity requiring capital investment and cash flows from net operating expenses, offset by new revenues. 

Investors and lenders want to see cash flow forecasts in business plans to evaluate the adequacy of future cash flows when making investing and lending decisions. 

Reporting actual cash flow, presented in a cash flow statement, is necessary to meet GAAP and SEC reporting requirements for adequate corporate governance. Internally, cash flow statements can be compared to cash forecasts for the periods to increase future cash flow forecasting accuracy and improve liquidity management.  

Conclusion – Cash Flow Forecasting

This article provides a cash forecasting definition and explains:

  • How cash flow forecasting is used by the business and its stakeholders, 
  • Cash flow forecast benefits 
  • Cash flow forecasting tools
  • Cash forecasting methods with example templates 
  • Items to include in a cash forecast or cash flow statement, and 
  • Why cash flow forecasting is important in business.

To learn about better cash flow forecasting, download our eBook, “The Ultimate Accounts Payable Survival Guide.”

About the Author

  • Linkedin