The Ultimate Guide to Cash Flow Forecasting for Startups

Written by Chris Brown
March 1, 2023

For startups, cash is king. Liquidity not only helps you make it to the next round of funding, but also allows you to remain flexible. Flexibility means room to test and iterate, or to pivot if the market demands it. It means being able to take advantage of time-sensitive growth opportunities and hold on to equity.

In spite of all this, many startups have nowhere near the 12–18 months of runway they should have.

The key to extending your runway? Cash flow forecasting. With a clear picture of how each action you take today affects your finances tomorrow, you’re no longer walking blind.

While cash flow forecasting is one of the most important things you can do for your startup, it’s a big topic. In this guide, we’ll break it down for you. Read on to learn everything you need to know about startup cash forecasting.

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Why Cash Flow Forecasting is Non-Negotiable for Startups

First of all, every business should forecast cash flow. But for startups, who often have very limited capital, it’s critical. 

After all, founders can’t always depend on more investment. You have to use the funds you do have as efficiently as possible – by estimating your future cash position, cash flow forecasts act as a guide. For example, if you see making some hires means you can’t afford payroll in a few months, you probably shouldn’t make those hires! Alternatively, forecasts can show you if you have idle capital you should channel into (sustainably) growing your business.

They’re the key to keeping your cash runway at an optimal length and your cash burn rate at that elusive number – enough to allow your company to grow, while still being able to pay for liabilities. You get a long-term, bird’s eye view of your runway, providing insight on when you’ll need to raise funds, and for what amount. 

Speaking of funding, solid startup cash forecasting can help you get it in the first place! You can – and should – include forecasts in your pitch deck. Especially now, with many worried about a possible downturn, VCs want to see companies in a healthy financial position before they invest.

Forecasts also show you your breakeven and help determine valuation. Just about everything relevant to startups is touched upon by cash flow forecasts.

Most founders are optimists at heart, but the sad reality is around 40% of startups fail due to lack of cash. Optimism needs to be tempered by numbers – to grow sustainably, you need a data-backed plan. Running regular cash flow forecasts is the first component.

Check out this clip from Fintech Corner, where host, Joseph Drambarean, and Trovata’s Director of Client Services, Kevin Bell, discuss why it’s so important for startups to be able to accurately forecast cash:

How to Perform A Cash Flow Forecast

Choose a Time Frame

Depending on what your goals are, cash flow forecasts can be as long or as short as you choose. Some common forecast periods include:

  • 2-4 week forecast – best if day-to-day granularity is important for your business. Since there aren’t any variables, a short-term forecast gives you the most clear, unbiased view of your cash flow.
  • 13-week forecast – provide a quarterly view. Short enough to be fairly accurate, but long enough to give you time to address anything projected (a shortfall, for instance). Ideal for budgeting and planning out loan repayments. 
  • 12-month forecast – ideal for long-term liquidity planning. Less useful for brand-new startups, as they won’t have sufficient historical data to work from.

Keep in mind that, the longer a forecast is, the less accurate it becomes. If you have a year or two under your belt, though, you can run longer forecasts in conjunction with shorter forecasts.

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Choose Your Method

There are two types of forecasting methods: the direct method and the indirect method.

The direct method is better for short-term forecasts, and works off known inflows and outflows. If you wanted to see what your working capital would be at the end of the month, for instance, you’d use the direct method.

The indirect method is more speculative, and better for long-term forecasts with unknown quantities. For the indirect method, you’d use a projected or pro forma balance sheet.

Since short-term liquidity is usually the primary concern, the direct method is most likely what you’ll be using for startup cash forecasting.

List all Inflows and Outflows

As an example, say you’re going for a 13-week forecast. You’d first estimate inflows over those 13 weeks. Then, do the same for outflows. Include everything: loan payments, marketing costs, payroll, and even your own wages. Record both numbers.

Determine Your Net Cash Flow

Once you have your estimated inflows and outflows, you can determine your net cash flow.

To calculate your net cash flow, simply subtract inflows from outflows.

Net cash flow = Inflows – Outflows

Subtract this amount from your bank balance at the beginning of the period, and you’ll see your estimated cash amount for the end of the period.

If you have a negative cash flow, you’ll know you need to do one or more of three things:

1) Reduce expenses

2) Increase revenue

3) Raise funding

Of course, there’s a lot more to cash flow forecasting than this – this is just a simplified view. Below, we’ll get into the nitty-gritty and look at some ways you can refine your forecast, along with some common forecasting mistakes.

Cash Flow Forecasting Tips

Adjust Your Forecasts

Forecasts are just that – forecasts, based on your own estimates. Using the 13-week example again, it’s very possible that inflows and outflows over that period could differ from what you expected. Maybe you forecasted revenue from a certain amount of customers, but actually had fewer. If so, recalculate your cash flow to give you a more current view to work from.

Do Variance Analysis

Sometimes, your forecast results will be way off. If so, you need to find out why so you can forecast more accurately next time.

To do this, you’ll want to compare your budget to your actuals. For example, if you had $5,000 set aside for SaaS spending but spent $6,000, you’d have a positive variance of +$1,000.

Alternatively, you could underspend. Maybe you forecasted that you would spend $50,000 on advertising but spent only $40,000. In this case, you’d have a negative variance of -$10,000.

Say you have a negative variance like this. Even though you’re spending less money, this isn’t necessarily a good thing. Why? Well, because you could be spending less on an area that drives revenue and so be reducing your cash flow in the long-term.

Variance analysis helps you spend capital more efficiently by showing you which actions resulted in increased cash flow. If you spent less money on a marketing avenue than projected, and have decreased cash flow as a result, you can ascertain that that marketing was driving revenue.

In other words, variance analysis shows you the quality of your spending.

Budget and forecast variance may indicate a few things: you may be using bad data, or have overly ambitious projections. Whatever the case, readjust. 

Look at Working Capital

Working capital is the amount of usable money you have at any one time. A positive working capital tells you you’ll be able to afford liabilities like bills or payroll, while a negative one means you need to make adjustments. 

To determine your working capital, first you need to ascertain the value of your current liabilities and the value of your current assets. Don’t forget to include accounts receivables and accounts payable (under current assets and current liabilities, respectively).

Once you have those numbers, subtract current liabilities from current assets to get your working capital:

Working capital = Current assets – current liabilities

Looking at working capital is the best way to figure out if you’re putting too much money into long-term growth at the cost of being able to meet short-term liabilities. 

Lack of working capital can be insidious – it’s actually possible to be making a profit but run out of working capital. This is because the lineup between payments and expenses can be off – for instance, maybe your payments are arriving every thirty days but, since you just began your relationship with a certain loan provider, you have to pay them up front.

Take steps to readjust the timing of revenue and expenses so that you never run out of working capital. For instance, provide incentives for early payments and delay repaying loans as long as possible (without accruing interest).

Do Scenario Planning

What if your sales are much fewer than predicted, or a certain supply chain gets disrupted? Will you have enough runway to make it to the next round of funding?

Scenario planning helps you answer these questions. It’s critical for startup cash forecasting, but requires some brainstorming. Think of possible political or economic issues, for example, that could affect your business. Maybe there’s an increase of regulation in the industry, or the exchange rate for your supplier’s currency moves in their favor.

Consider the worst case scenario in each category, and how this would affect your business. How would you respond?

Cash flow forecasting software can make it much simpler to project these kinds of hypotheticals. With user-defined growth variables in Trovata, you can project for specific scenarios, such as a particular supplier becoming disrupted or increasing their prices.

Planning for scenarios automatically gives your startup an advantage over those who don’t. Remember that downturns also present opportunity – you may have the chance to buy up competition and emerge to a much less crowded field.

Common Forecasting Mistakes

Using Flawed Data

A cash flow forecast is only as good as the data you put into it. While making cash flow forecasts with spreadsheets can definitely work, the potential for error is high.

One solution to this problem is open banking APIs. APIs source information directly from company bank accounts. Since there’s no “middle man,” there’s no chance of transcription error – you’ll always have real-time, accurate insight into your cash flow.

Not Maximizing Your Resources

Sometimes, it seems like startup life is all about flying by the seat of your pants. Not only do you have limited capital, but you may have to work with small teams. Team members often have to wear multiple hats. By using software, you ensure your staff is as efficient as they can be.

With automation, for instance, treasury teams can make the shift from data gathering to quality data analysis – a much more productive use of time.

But legacy TMS can be labor-intensive and take a lot of time to integrate. They’re also expensive. Fortunately, today there are many high-tech alternatives that are streamlined – in other words, the best at what they do. No need to pay for all the extra bells and whistles you may not even use (another common source of cash burn, by the way!).

Automation is especially important for fast-growing startups that are driving a lot of volume. By using banking APIs through Trovata, for instance, CrowdStrike’s treasury team was able to save 40 hours a month.

Lack of Communication

Transparency is critical. Bring in all stakeholders from all departments to ensure your cash flow forecasting reflects every ongoing financial initiative. 

Overpaying on Payments

One area many don’t think about is payments. Payments aren’t free – wire transfers, for example, cost around $25 domestically and $50 internationally. These amounts are relatively small, so you may just chalk it up to the price of doing business

But they add up. Rethinking the way you do payments is one way to reduce cash burn and extend your cash runway.

For companies that wire money frequently, real-time payments are a lifesaver. The first new payments rail in the U.S. in over 40 years, RTP transactions are both cheaper and faster than wire transfers. But they’re not yet available everywhere, and some banks, like J.P. Morgan, currently only offer RTP through APIs like those used by Trovata.

Batch payments are similar to bulk payments in that payments are bundled together. However, since each ACH payment is processed individually, you won’t get charged by your bank for making a bulk payment.

Not Using Current Technology

In 2023, we’re in the midst of a technological revolution. AI, big data analytics, and open banking APIs are all coming together to change the way companies operate.

This is particularly true when it comes to startup cash forecasting. Spreadsheets were the old way of doing things. You’d have to run from bank portal to bank portal to collect data and record everything, hopefully without any errors. Then, for every new forecast or scenario plan, you’d have to start from scratch.

Now, with open banking APIs, all transaction details can be brought directly to a central platform – you get real-time insight into your cash flow without the hassle of manually sourcing information. 

With Trovata, cash flow forecasts are generated automatically, while AI refines your forecasts based on historical data. Machine learning grows to understand how your business operates with every forecast that’s performed, alerting you to areas where unnecessary cash burn is occurring.

Going forward, analytics is going to be the name of the game – Trovata allows you to dig deep and stay one step ahead of your competitors.

Build Your Cash Flow Forecast With Trovata

While outside investment may act as the springboard for your startup, solid cash flow management ensures it sticks the landing.

Trovata has helped companies like Krispy Kreme, Square and CrowdStrike gain deeper insights into their cash flow through automation, and we can help you too.

Get started with a free account today.

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