How to Forecast Cash Flow [5 Reasons You Need One Today]

I had a business finance professor that often repeated the mantra, “cash is king!”  Whether your business is large or small, growing or declining, not-for-profit or for-profit, cash is the lifeblood of your business.  Growing businesses must consider whether they have enough cash to support growth plans.  Declining businesses use a cash forecast to ensure it is not trading while it is insolvent.  Seasonal businesses must predict how much inventory they can afford to purchase to prepare for an upcoming peak.  To be sure, cash management is critical for all businesses.  Unfortunately, many business owners fail to forecast cash and are surprised when they have a business aneurysm: E.g. they don’t have enough cash in their bank account (or capacity under their operating line) to pay suppliers or make payroll.

Why Create a Cash Forecast?

Business owners should forecast cash flows for the following five reasons:

1. To create an early warning system.  

A business owner that can predict that a cash shortfall is coming has many more options and time to address it than a business owner that gets surprised by a cash crunch.

2. To identify problems with customers.  

Preparing a forecast can help a business owner learn which customers are paying their debts timely and which are not.    

3. To ensure the business can pay suppliers and employees.

Suppliers who don’t get paid will soon stop supplying the business.  And worse, employees that don’t get paid will stop showing up for work!

4. To comply with requirements by lenders.  

Many lenders require borrowers to provide cash flow reports, to ensure the business is liquid.

5. To control the way cash is expended.

Many business owners are surprised by the number of ways cash leaves their business.  For instance, some business owners are surprised by the amount of travel and entertainment expenses made by employees through company-issued credit cards.  Cash forecasts alert the business owner to the ways cash is expended and can assist in managing them.

How is a forecast created and managed?

Cash forecasting does not need to be highly scientific or overly complex.  I often tell clients it’s as easy as kitchen-table budgeting, and when implemented right, can take less than 30 minutes to manage each week.  A proper cash forecast is built as follows:

  1. Determine the frequency you will update and review the cash forecast.  Companies in fast-changing environments or teetering on solvency should forecast cash weekly with a 13-week horizon.  Stable companies can manage with monthly forecasts and should look forward at least six months.
  2. Enter the current beginning cash balance of your company’s cash account(s) into a spreadsheet.  Or, if your company operates under a line of credit, enter the line availability.  This number should be net of any outstanding checks that have not yet been presented.
  3. Forecast all expected cash disbursements for each period, paying close attention to wages, payroll taxes, and so forth.   For the closest weeks, use the accounts payable aging report to determine which bills will be paid and when.  For later weeks/months where bills have not yet been received, make estimates based on historical actuals, your knowledge of the business, etc.  Make estimates for non-trade disbursements too such as capital expenditures, sales, and use taxes, interest payments, credit card, and debt service payments, and so forth.
  4. Using a similar process, forecast and total all expected cash receipts for each week (or month).
  5. Cash receipts will include receivables expected to be collected by week (or month) from customers.  For short-term forecasts, work from the accounts receivable aging report.  For each open account, list when each invoice will be paid and insert it into the forecast.
  6. Other expected cash receipts should also be forecast, such as asset sale proceeds, insurance settlements, vendor rebates, advertising coop receipts, and so forth.
  7. Subtract total disbursements from total receipts to compute the net change in cash week-over-week (or month-over-month).  
  8. Add or subtract the net change in cash from the beginning cash balance to compute the ending cash balance each period.  Roll the ending cash balance from the first period to the beginning cash balance of the second period and repeat.

Business owners should track actual performance against the forecast weekly or monthly to learn what cash receipts were expected to be collected, but were not, what unexpected disbursements were made, and what the company’s short-term liquidity position is.  If there are ever any periods where the ending cash balance (or line availability) is forecast to go negative, the business owner needs to either identify additional sources of cash; accelerate collections; or delay disbursements.

It’s been twenty years for me since my finance professor crowned cash as king.  Since then, I’ve consulted with dozens of business owners with unique sets of challenges and opportunities, but each has had a common goal to maximize cash.  The business owners that have implemented the principles and practices above have grown, improved, and recovered their businesses.  My professor was right.  Cash really is king.