Cash flow forecasting is one of the most important things you can do to ensure the success of your small business. But it can also be one of the most frustrating.
It’s like eating your vegetables. Not necessarily that fun, and sometimes a bit of a challenge to get through, but sure to make you (or your business) way healthier in the long run.
Usually, cash flow forecasting involves manually recording every transaction, tracking down historical data across multiple bank portals, and then plugging this information into spreadsheets or other types of planning software.
Only once you’ve done all that can you actually begin creating your cash flow forecast. This could take hours or even days, depending on the size and expertise of your team.
Fortunately, forecasting software for small business presents a highly-effective alternative. By using software that automates all the processes mentioned, you save yourself plenty of time while also ensuring data is free of errors. That way, you have more time for things like FP&A, demand planning, workforce planning, and sales forecasting, all the while having solid data to make better decisions.
What is Cash Flow Forecasting? Why Is it Important?
Building a cash flow forecast lets you know how much cash your business will have on hand in the future.
An accurate forecast acts as a guide. Say it shows you have a negative cash flow, i.e., that you’re running out of money. You won’t be able to meet payment due dates two months from now – the guide has shown you it’s time to scale back expenses. But if the forecast shows you have a healthy, positive cash flow, you can use that extra capital strategically to grow your business.
Essentially, cash flow forecasting all comes down to sustainability.
If your current business model is not sustainable, an accurate cash flow forecast will sound the alarm. From there, you can make adjustments to your spending and get back on track. If you have a surplus of cash, forecasting will also help you determine how fast you can grow without running out of resources.
Sadly, we know that most businesses fail. But did you know 82% of small businesses fail as a result of running out of cash? This means they either overestimated sales or underestimated expenses, or were not financially prepared for a crisis.
From this, we can infer that 82% of small businesses that failed did not regularly create cash flow forecasts. If they did, they probably weren’t very accurate.
So, we can honestly say that an accurate cash flow forecast will help protect your company from the primary risk that faces small businesses! Pretty powerful stuff.
Use Small Business Forecasting Software, Not Spreadsheets
Consolidating data the traditional way can be incredibly time-consuming. Jumping from bank portal to bank portal and recording data in Excel or Google Sheets can take days. Usually, by the time all the data has been collated, it’s out of date.
Wouldn’t it be great if everything were recorded automatically in one central dashboard? You could see all transactions, internal and external, as they were occurring.
Real-time insight into your cash flow is one of the most important functionalities provided by forecasting tools.
This real-time insight is possible thanks to a technology known as APIs. API stands for automated programming interface, and these tools allow for direct communication between your bank accounts and forecasting software. This is known as open banking.
So, with your express permission, all your current data is brought to the same place. There, you can view it easily and make cash flow adjustments on the fly – you don’t even need to log into your separate bank portals.
The best cash flow forecasting software also permits Enterprise Resource Planning (ERP) integration. This helps complete your financial picture – by integrating an ERP such as Sage, you’ll have access to unpaid bills and liabilities. After all, no matter what forecasting model you use, no cash flow forecast is complete without ARs and APs.
With open banking and ERP integration, you have an incredible view of your business’s cash position that’s easily accessible from one, central platform.
All this not only saves you time, but also allows you to make informed decisions quickly. This is critical in times of crisis, as we saw when the COVID-19 pandemic first hit in 2020. When something unexpected happens, you don’t have time to collate a bunch of data over days or even weeks – you need actionable information ASAP.
With forecasting software, this is exactly what you get – cash flow reports generated automatically.
Automation also saves your cash flow forecasts from human error. According to IBM, 88 % of spreadsheets include at least one error. Just one mistake could lead to liquidity shortfalls or missed opportunities to expand your business as you either overspend or underspend. You then spend more time trying to track down that error when you could be making strategic decisions related to your future growth.
Challenges of Forecasting For Small Businesses
High Cost of Legacy Treasury Management Systems (TMS)
Maybe you’re already convinced of the need for small business forecasting software and have been looking into treasury management systems (TMS). But, during your search, you’ve discovered that most legacy TMS’s pricing is high. For your own profitability’s sake, you decide to use Excel, and simply manage all the problems listed above.
To that, we have two points:
- Not all TMS are expensive – some even have free models
- By saving time, you also save money
If forecasting software reasonably fits into your budget, it’s more than worth it (assuming it has excellent reviews, that is). Again, if there’s any single planning tool you can justify investing in, it’s cash flow forecasting software (which is not the same as accounting software). That’s because it makes bank data consolidation a breeze, and it’s almost impossible to do proper financial decision-making without it.
Lack of a Dedicated or Experienced Finance Team
Small businesses don’t necessarily have the resources to support a large finance team or financial forecasting tasks. You may only have a handful of employees who are inundated with invoicing, accounting, and operational planning. In these cases, forecasting software can carry the weight for you.
You may also lack financial expertise – whereas something like Excel can be a specialization in itself, cash forecasting software is much more intuitive.
“With Trovata, “[the] Cash Analysis…feature allows you to view weekly, monthly, or quarterly trends at a click of a button.”– Aurelia Sirbu the CFO of event and exhibitions company, Orbus.
When reports are generated automatically, you all you have to understand is how to make sense of the information, how they relate to your business metrics and KPIs, and how to turn it into actionable advice.
Fortifying Your Cash Flow Forecast for Better Business Planning
Not all cash flow forecasts are the same. When it comes to the forecasting process, you need to do a few things:
- Make sure the input is accurate,
- Tailor the specific forecast you use to your business and
- Take into account seasonality and/or plan for fluctuations, both minor and major.
Follow the tips below to make your forecast as strong as it can be.
Do Scenario Planning
Planning for different scenarios helps you know whether your small business could survive a specific crisis.
This is especially important to do now, in uncertain economic times, with many analysts predicting a recession in 2023.
Financial planning with Trovata’s software solution can help by allowing you to run projections with user-defined growth rates and variables. This way, you can see where your business would be if a Covid-19 sized pandemic hits, and you lose access to specific suppliers, for example. Trovata’s user-friendly tagging system helps streamline this.
“By tagging certain vendors/transactions/amounts, you can build full cash forecast, partial cash forecast, individual vendor forecasts, or anything else you might want.”– Jonathan, a Senior Treasury Analyst of a healthcare company
Understand Working Capital
Working capital is related to, but different from, cash flow. It shows the difference between your current liquid assets (cash and items that can be easily converted into cash) and your current liabilities (debts, overhead, payroll, etc.).
Having a positive working capital doesn’t mean you have a positive cash flow – it’s simply telling you that you can afford expenses now, not necessarily a few months down the line. That being said, it’s ideal to ensure your working capital is in the green. This means you have a buffer should your business face unexpected downturns. For this, you’ll want to calculate your working capital ratio.
To determine your working capital ratio, divide your current assets by your current liabilities.
If the number is at or greater than 1, it means you have enough to pay for your expenses. But we want some wiggle room – aim for a working capital ratio of between 1.5 and 2 to ensure you’ll have some space if a crisis occurs.
Account for Seasonal Fluctuations
If your business does better or worse at a certain time of year, make sure to include this information in your cash flow forecasts.
You’ll also want to make sure your working capital is higher during the down months so that you can ride out expenses with less revenue.
Choose the Right Length of Time
Each cash flow forecast assesses a certain length of time, so which is best? Well, it depends on how your business operates and what you want to accomplish.
If day-to-day granularity is paramount to your success, you’ll want to choose a short-term forecasting method of 1–3 weeks.
Alternatively, you may have heard of the 13-week forecast, one of the most popular options.
13 weeks is an ideal length of time for most business’ financial reporting – not too long, and not too short. Since they evaluate entire fiscal quarters, 13-week forecasts are especially useful for planning budgets. They’re also typically used to respond to incoming liquidity shortfalls.
So, if you’re projected to run out of money – in other words, if your cash burn rate is too high – use a 13-week forecast. A solid 13-week forecast can also help you secure access to financing, should you need it.
Keep in mind that the longer a cash flow forecast is, the less accurate it’s likely to be.
Things change and, while relevant data now will probably still be relevant in 3 months, it may not be in 12 months.
Anything beyond 12-months won’t be super useful, as the main purpose of cash flow forecasting is to tell you what you can do now to ensure your business is on the right track.
However, it’s a good idea to run both short and long-term forecasts – each informs the other and helps you get a clearer picture of your overall cash position.
Don’t Forget Variance Analysis
Variance analysis helps you refine your forecasts. It does this by showing you the difference between your forecast baseline and your actuals. If there’s a large difference, you need to investigate what you missed. Did you overestimate expenses, or incorrectly record something?
The Future of Forecasting
Over the past few years, we’ve been witnessing a quiet revolution as fintech has changed the way businesses forecast their cash flow. It began with the EU’s PSD2, which mandated banks share their data with qualified third parties. Since the introduction of that law in 2018, this transformation has been spreading gradually around the world.
So, besides integrating information from across bank portals, what other problems are solved by open banking?
For one, payments can be initiated across banks. While in the past decade, many third-party platforms have tried to go around banks, providers like Trovata don’t do that. Rather, they make it so you can initiate and receive payments using banks’ payment rails right through the central platform.
Next, cash flow forecasting can only be accurate if all data is verified. If a company has multiple departments, or multiple employees, who are editing cloud-based spreadsheets, it can be difficult to keep things consistent – which version of the spreadsheet is most current?
This is the problem of data silos. Open banking gets around this problem by presenting a single, accurate source of truth in the form of real-time cash visibility.
Machine Learning and AI
Machine learning and AI are some of the most exciting innovations in the space, both of which are used as key features of Trovata’s forecasting software.
APIs bring information across bank portals right to machine algorithms. With this error-free range of data, machine learning algorithms generate super accurate predictions almost instantaneously.
Machine learning also becomes more and more accurate over time as the algorithms understand how your business operates.
If your forecasts vary over time, machine learning can help provide insight into why this is happening though displaying forecasts and actuals. Artificial intelligence evaluates your business’s current financial data and historical data, and makes predictions based on this data.
Secure and Grow Your Business With Trovata
We’ve said it before, and we’ll say it again – cash flow forecasting is the most important thing you can do for your business, and the data bears this out. Using software helps make your forecasts as solid as they can be, ensuring the foundation of your business – your cash position – is as strong as possible.
Trovata can help you understand your cash flows and financial performance. Our software is engineered to help companies of all sizes guarantee their future. How? By making cash flow forecasting as easy and informative as it can be.
Want to see our forecasting solution in action? Request a demo today!