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The Importance of Cash Flow Forecasting

All business owners need to have a clear understanding of the financial ins and outs of their company in order to keep their business afloat. Cash flow forecasting is a useful method for any business to do just that. 

Cash flow forecasts are plans, based on estimates, of a company’s future cash position. Typically, a cash flow forecast will lay out the estimated cash inflows and outflows for a given future period, offering a prediction of the business’ expected net cash flow for that period. 

According to the Office of National Statistics, 90% of business failures are the result of cash flow issues. Using a cash flow projection method can be crucial to helping businesses to avoid and prepare for future cash flow challenges.

 

Advantages of Cash Flow Forecasting

There is a great range of benefits of cash flow forecasts for eCommerce businesses, aside from gaining a granular view of business transactions.  

  • Anticipate future cash shortages

The nature of a cash flow forecast is to understand whether a business will experience positive or negative cash flow in future periods. By identifying potential future cash flow gaps, businesses can take measures to prepare for these such as reducing cash outflows for that month, using credit to pay suppliers, or saving surplus cash for these periods. This is a particularly important benefit of cash flow forecasts for businesses who experience significant seasonal sales fluctuations.

  • Track expenditures

Creating a picture of projected cash outgoings over a given period can also allow you to more closely track and understand your regular business expenditures. Allowing you to see areas where you may be overspending and could cut costs to improve cash flow. 

  • Monitor late paying clients

Cash flow forecasting can also give you insight into clients who regularly pay late and impact your cash flow. By identifying these clients, you could create more strict credit periods to improve your cash flow and avoid periods of negative cash flow due to these late payments.

  • Run hypothetical business scenarios

Scaling and growing your business always comes with a degree of risk. Using cash flow projections, you can play out the financial implications of hypothetical  business scenarios such as investing in new production equipment, offering next day delivery offers, or understanding the cash flow implications of launching a seasonal product range. 

  • Support more informed business decision making

As mentioned above, playing out hypothetical scenarios using cash flow forecasts can help to understand the risk or reward of new activities. Additionally, this also supports more informed decision making as you will have the financial information to either push for or reject certain business ventures. Ensuring that your business does not invest in a decision that could jeopardise cash flow over the long term.

  • More effective surplus cash management

Just as cash flow projection can be used to identify periods of negative cash flow, it can also be used to predict periods of positive cash flow. Being aware of when you will have surplus cash available will allow you to use this positive cash flow balance to your advantage. 

For example, you may experience fluctuations in sales across different seasons, and over the next month you are expected to experience positive cash flow in line with this. Using cash flow forecasting, however, you notice that next month you will see a drop in sales and a negative cash flow. With this information, you can save your positive cash flow balance and bring it over into the next month to help cover expenses that cannot be accounted for using sales revenue alone. So your business can more easily work through this upcoming negative cash flow period. 

Additionally, you could see that a prolonged period of positive cash flow means you have enough surplus cash to invest in new equipment or processes that could benefit your business in the long run.

 

Disadvantages of Cash Flow Forecasting

There are also some disadvantages of cash flow forecasting that all businesses should be aware of before relying on these projections too heavily.

  • Forecasts are based on estimates and probabilities

Cash flow forecasting is based entirely on projected estimates and probabilities, and because of this, plans become less accurate the further into the future they extend. To increase the accuracy of forecasts, compare projections to actual bank statements for the same period and adjust future forecasts accordingly to create a more accurate picture.

  • Cash flow forecasting can create a false sense of security

Cash flow forecasts are just that, forecasts. If a forecast predicts prolonged periods of positive cash flow this can cause businesses owners to fall into a false sense of security. Additionally, it is important to be aware that cash flow is not the same as profit, and prolonged periods of positive cash flow are not a definite indicator of future business success.

  • Forecasts cannot be solely relied upon

Business can be unpredictable, and cash flow forecasts are not designed to anticipate future market changes, shifts in sales demand, inflation or other factors outside of your business’s control. Therefore a cash flow forecast should simply be used for guidance and should not be fully relied upon.

  • Leadership can develop tunnel vision from over-reliance on cash flow forecasting

Over-reliance on cash flow forecasts is not advisable, but if it does happen, there can be consequences outside of just negative cash flow. The business decision makers could develop tunnel vision, disregarding external factors that could be detrimental to other aspects of the business or even profitability. While cash flow forecasts are a great support for business decisions, there are still many other considerations to make to keep your business running smoothly.

 

Cash Flow Forecasting Methods

Cash flow forecasting in itself is an important tool, but using the right type of cash flow forecasting method can make your projections even more valuable to your business. Some of the most common cash flow forecasting methods include;

  • Cash forecasting - indirect method</h3>

The indirect method of cash flow forecasting uses net income to create cash projections. Net income figures are found on the profit and loss statement, and are adjusted by removing all non-cash transactions to quickly give a prediction of cash flow. Although this method is much faster than other forecasting methods, it does provide a less accurate forecast of future cash flow.

  • Cash forecasting - direct method

Direct cash flow forecasting is the more typical method of creating cash projections. Direct method forecasts are made by creating a cash flow statement that accounts for all of the individual predicted cash transactions over the given period, subtracting projected cash outflows from projected cash inflows to give the cash flow forecast.

  • Product forecasting

Product forecasting is a more specific version of traditional cash flow forecasting. Product forecasting is used to predict the success of a new product by considering the product’s awareness or any marketing campaigns, the price, the product’s niche, projected sales and competitor alternatives. Product forecasting naturally provides a much more limited view of your overall cash situation, but can be useful to use alongside traditional cash flow forecasting methods to understand the potential impact of a new product launch.

  • Three-way forecasting

Three-way forecasting offers a holistic view of your business’ projected financial position. This method of forecasting projects profit, balance sheets and cash flow together. This method can be particularly useful if you need a wider view of your business’ finances as there are many expenses that are not included in a cash flow statement such as inflation, and others that are not included in a profit and loss statement such as VAT movements. 

No matter which method of cash flow forecasting suits your business, there are some core best practices that all business owners should consider. 

  • To create more accurate future cash flow forecasts, compare old forecasts to actual bank statements. Make necessary adjustments to future forecasts based on the differences between your statements and forecasts.

  • Consider some of the finer details that can influence your cash flow forecasts. When do you customers typically pay you? Is this usually within your anticipated payment window or are there late payers that can create cash flow problems?

  • Regularly revisit your forecasts throughout the period, update with any unexpected expenses to give you a more accurate picture of what your bank statement will look like at the end of the period.

  • Remember, cash flow does not equal profitability.

 

Conclusion

When used correctly, cash flow forecasts can be a highly valuable tool for eCommerce businesses. No matter which method of forecasting suits your business interests, understanding projected future cash flow can keep your business afloat in challenging times and even support growth in the long-term. 

For more guidance on how to get started with cash flow forecasting, what cash flow means for your business and how to improve your cash flow, download our other eBook chapters. 

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