The 5 Secrets of Cash Flow Forecasting

By Ken Kaufman on 30 July 2010 0 comments
Photo: mgkaya

While forecasting cash flow may sound like a smart idea every business should implement, you might be surprised how many don't. Most businesses have no formal cash flow forecasting process in place to plan for and manage the short-term excesses and shortages (also known as peaks and valleys) of cash flow every business experiences. Regardless of what accounting software you use, it is often best to start your forecasting efforts in a spreadsheet and then try and automate the process with software. Here are the five key secrets to accurately forecast and maximize the cash flow of your business.

1. Weekly for at Least 90 Days into the Future

It is usually appropriate to look at cash flow on a weekly basis — usually as of the last working day of each week. It should also extend, by week, at least 90 days and as many as 180 days into the future. Depending on your needs, between 90 and 180 days is usually sufficient for short-term cash flow. It is important to compare the actual cash flow results from each week to your projections to improve your assumptions each week.

2. Collections by Customer

Now that you have the timeline and frequency handled, you need to look at your cash inflows, which primarily come from customers. First, you need to determine how long it takes to collect from each customer (if you have less than 50 total customers). If you have more than 50 customers, then you need to separate your customers into payment classes such as credit card sales, cash, net 15, net 30, and so on. Second, you should schedule out when you are expecting payment, by week, for each of your existing receivables. Third, based on your sales projections by customer or payment class, you need to project your subsequent collections for the duration of the forecast. Often the best way to do this is to look at weekly sales for the prior few years and project based on growth or shrinkage factors for each customer or customer class.

3. Separate Variable and Fixed Outflows

It is almost always easiest to separate the variable from the fixed expenses by vendor and type. The variable expenses will be driven by your sales projections and the terms with each of the vendors in this category. The fixed outflows include all cash fixed expenses plus debt payments and regular distributions to owners, if there are any. You may need to separate the variable and fixed portions of payroll and payroll taxes, but you need to make sure they are included.

4. Taxes and Other Quarterly and Annual Outflows

I seem to meet at least one business every month that does not properly plan for its need to pay for taxes in its projections. The result is a business that has to delay other payments and, sometimes, even payroll until the cash flow cycle recovers. Since a lot of businesses are operated as flow-through entities to their owners, the owners typically distribute money either quarterly or annually to meet their income tax obligations. The cash flow projection needs to include the payment of all taxes to manage its impact on the peaks and valleys of the cash flow cycle in the business.

5. Bridge Valleys with Financing

So, why do you bother to go through all of this effort to understand your short-term cash flow? Among many other reasons, so you can see in which weeks your cash flow will become negative, how long it will stay negative, and by how much it will go negative in each of the valleys in your cash flow cycle. If the cash flow is only negative for a week or two, then you can likely handle it by slowing down your payment of payables or through some other working capital "tweak." If it is longer than a few weeks, then you need to plan for how you use other sources of financing to bridge the valley until cash flow recovers.

Not knowing what will happen to cash flow at least 90 days into the future is a great source of anxiety for most businesses. Conversely, having an accurate projection of cash flow that is updated each week removes the anxiety of the unknown and empowers the business to solve any problems or issues before it is too late.

In addition to maneuvering through the valleys of cash flow, it is almost as important for a business to manage its excesses, or peaks, as well. Whether it is merely implementing a treasury management solution to earn some interest or to know that the business has enough cash make a critical capital expenditure, forecasting cash flow will empower any business to manage and plan for its most vital resource — cash.

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