The Benefits of a Cash Flow Forecast
Learn the advantages of a cash forecasting routine.
By Gregory Brickner
February 4, 2020 • 8 min read
Entrepreneurs must consider the cash flow of their businesses. Another aspect to carry out is a cash flow forecast.
A cash flow forecast estimates and predicts the inflow and outflow of cash into a business’s bank account. A forecast is normally made for every end of the quarter or month.
There are many benefits of a cash flow forecast when executed and used properly. Here’s a list of its many advantages.
Having a cash flow forecast can help a business owner identify the area where cash is overpaid. This is possible to check manually. Yet, it’s easy to overlook overpayment without a forecast.
For example, utility bills might be set at a steady figure for several periods. This helps the business owner calculate the total cash outflow per period.
If the total for a certain period exceeds the calculation, it’s easy to identify which area has been overpaid.
Predicts the effects of upcoming plans and feasible outcomes
A great business owner must have several forecasts for various scenarios. This will give the best option for what an entrepreneur must do next.
Since small businesses don’t have massive capital, unlike big corporations, every penny that flows in and out of the business is crucial. It’ll also give the business owner confidence in his/her decision-making skills.
For instance, an online clothing business owner may plan on hiring more employees to give better customer service to their clients.
He may create a forecast on three scenarios; gaining more customers through better feedback and more sales, having steady sales while paying more employees, and failing sales for the period because the move wasn’t executed as planned.
Through these forecasts, the owner can decide whether he would continue the plan or think of actions for the worst-case scenarios.
Assures that employees and suppliers are happy
A forecast can also make a business owner sure that he can continuously afford to pay employees and suppliers.
In worst cases, a business owner who isn’t prepared may end up losing reliable employees and sources. A forecast can give an owner ample time to set up preventive and countermeasures.
For example, if one period would end up with bad sales, a business owner may have already prepared a business loan beforehand if a forecast was made.
Creates a rapid learning curve of the cash flow patterns and trends
A business is an unending journey of learning. Through continuous forecasts, an entrepreneur can review them to learn the patterns and trends that affect the cash flow cycle.
A business owner can understand which months have negative cash flow and the reasons behind it. He may also find out the choices he made, which resulted in positive cash flow.
Reviewing the patterns and trends, a business owner may create better future decisions that can help improve cash flow in difficult months.
Take this as an example. A flower store may not have great sales during February, May, July, and December for two years compared to other flower stores.
With forecast records, the owner may find out why this is happening. He can plan a different approach, which may help improve the sales of the business.
Identifies customer payment problems
Many businesses don’t have any problems with their customers’ payments. But for some businesses that offer installment plans to their clients, it may be an issue.
In this case, a cash flow forecast can help a business owner identify how quickly his clients are paying back their debts. This will also help him create a better payment plan for future clients.
Not being able to look at this aspect may result in negative cash flow.
Continues to operate a business in a failing economy
Successful businesses continue to grow even in a weak economy. One of their secrets is a cash flow forecast. A good forecast can aid a business in knowing where and when cash inflows happen. It will also give an understanding of the cash outflows.
With this information, the owner can manage employee wages, give approximate prices for services and products, and cut down on unimportant costs. This will help the business have higher chances to survive.
For example, a restaurant owner may expect to have a lower cash inflow in the coming months due to the poor economy. He may try to create new menu items that may utilize cheaper raw materials and price them at an affordable cost.
Prepares for credit lines and loans
Problems would always arise in a business, no matter how positive a business owner’s outlook may be. And in these tough times, business loans can be helpful. These loans can also lead to much bigger problems.
With a cash flow forecast, an entrepreneur may know when he would need to open a credit line or loan. It would also help him plan out when the inflow would be sufficient to pay back the debt.
Without a forecast, the debt may increase because the owner would lack preparation and planning. This may end up in bankruptcy and the loss of the business.
Better management of excess cash
There’ll be periods where inflows would exceed the expectations. This is a good sign that a business is going great.
But without a cash flow forecast, a business owner may spend this surplus cash poorly. Knowing when the excess cash inflow will appear can give the owner enough time to plan ahead.
For example, there’ll be a 10% excess in cash inflow for the first quarter. An unprepared business owner may get ahead of himself and use it for more expensive supplies.
Yet, a prepared business owner may foresee that the cash flow would be negative in the second quarter. He may decide to keep the excess cash from the first quarter to balance out the negative inflow of the second quarter. Without a cash flow forecast, the business owner may have decided poorly.
Have prepared forecasts when necessary
Businesses may need to provide cash flow forecasts for certain reasons. Besides bank loans, bigtime and even smalltime investors may ask for them.
This will assure them that their investments would not go to waste.
Many banks would ask for a cash flow forecast often on a regular basis to know if the business is capable of paying the debt back.
For investors, a forecast will prevent them from withdrawing their investments from the business.
When hiring a business counselor, a cash flow forecast is necessary. This will help the counselor give better judgment and advice to the business owner.
Aids in quick business plan changes
When a well-thought-out business plan isn’t going well, a cash flow forecast may help in making quick changes in the plan.
A forecast can aid a business owner in assessing different scenarios to know if the current business plan will continue to be successful. When the forecasts show negative cash flows, then the business owner may make necessary changes to the business plan.
For example, if an entrepreneur plans on importing supplies, the real figures in a cash flow forecast may help determine the outcome of his plan. He may switch to local suppliers if the forecast shows negative cash flow.
Allows the business owner to concentrate on other vital tasks
A cash flow forecast doesn’t need to be a tedious task since various software applications can help a business owner.
Using an application to create a cash flow forecast can give a business owner more time to focus on important tasks. It may only take a couple of minutes to set it up.
For instance, a business owner can focus on his employees, business growth, and building investor confidence.
Invest in a good cash flow forecast software that can give accurate results. It should also have enough tools that will make the job easier. There may be free software available online. Still, investing in reliable software can make the task quicker and more accurate.
To make it simple – an entrepreneur must practice forecasting the cash flow and not only on the amount of profit. A cash flow forecast may help prevent common problems that many inexperienced entrepreneurs face.
A cash flow forecast could also have a couple of disadvantages. One of the biggest problems that entrepreneurs face is an unpredictable payment that may affect the cash flow.
But these can be solved by creating several cash flow forecasts based on different scenarios. A business plan may include these negative scenarios, which should also be in the cash flow forecast.
Despite being a rough estimate, a cash flow forecast could still give an insight into a business’s future. Every move must be well calculated to match the forecast.
Business owners should also have good decision making and critical thinking to match cash flow forecasts. No matter how accurate a forecast is, improper decisions can still lead the business into chaos.
Take small steps when trying to initiate a new goal with a business. In this way, it wouldn’t be too difficult to create the forecast.