How to Create A Direct Cash Forecast

Written by Keegan Chamberlin
March 21, 2022

If you’ve never created a cash flow forecast, or are just looking for some best practices to improve your current one, this article will help you set up your cash flow forecast to fit the needs of your business.

It’s critical to know how to create and manage a cash flow forecast to ensure you have enough cash to run your operations today and tomorrow. Your cash flow forecast will help you know when you could run out of money, so you can make strategic decisions beforehand and ensure your organization never runs out of cash.

And while that sounds simple, it’s one of the most common reasons most businesses fail within the first five years.

How to Prepare a Direct Cash Forecast – 3 Steps

1. Determine Your Required Forecast Frequency and Accuracy

A direct cash forecast helps you better understand your organization’s current cash levels at a single point in time. It’s important to remember that every organization’s forecast requirements are variable and depend on the purpose of its forecast. Defining that purpose ahead of creating the forecast helps you determine your necessary frequency and level of accuracy.

Forecast Frequency

Frequency can depend on a variety of factors, but two critical ones are:

Is your organization cash-rich or cash-poor?

Often for small businesses or businesses that have been operating for only the past 3-5 years, many do not have a large cash reserve, so they must be strategic and protective over what they have in order to ensure they have enough funds to pay the bills.

Depending on your cash availability and banking relationships, you may consider forecasting weekly, if not daily. If you are working at a treasury for a cash-rich company, such as a Fortune 500 company, you may just need to forecast monthly to make sure the organization has enough cash to reach its strategic objectives for the quarter.

Does your organization have a big planning date arriving soon?

Perhaps your organization is considering acquiring a company or new equipment, implementing a share repurchasing program, or taking on long-term debt to fund specific long-term strategic objectives.

All of these one-off events also come with a large and untypical cash outflow that must be planned for in advance. Even if you are at a cash-rich company, leadership wants to ensure they have all the critical financial information they need.

With that, they better plan for these events and make better debt or investment decisions, requiring you to forecast more frequently than usual. 

Level of Accuracy

Most of us can agree that we would desire our cash forecast to be as accurate as possible, but gaining up to 99% accuracy could increase the time spent compiling and analyzing data that you just can’t afford to take away from other strategic objectives.

Perhaps your organization has enough cash in your reserves that you can afford your forecast to be 95% accurate instead. In that case, consider the opportunity cost on the 5% margin of error – what could you have done better with the money that was miscalculated?

Alternatively, maybe some of you reading this are working for a smaller company that doesn’t have a large cash reserve. That means your forecast has to be as accurate as possible to cover your base expenses. 

To determine your organization’s necessary forecast accuracy range, it’s critical to collaborate with key stakeholders, like the executive team. Communicating upwards the time and cost it would take to achieve greater forecasting accuracy is essential to enable equal access to data and confidence in the transparency of your direct cash forecast.

2. Break Your Cash Flow Down Into Inflows and Outflows

Developing a cash flow forecast may look simple on paper, but it can become more complicated as your business and treasury volume grows.

For start-ups, it may be straightforward as it is simpler to wrap your arms around all the business functions.

Global businesses have many more key stakeholders and divisions to consider, ensuring that a degree of automation is needed to maintain an accurate forecast.

It is crucial to understand potential sources of cash and outflows. In direct cash forecasting, cash is recognized when cash enters and leaves your bank accounts. This means that your cash inflow and outflow categories are going to be based on the methods your cash travels in and out of the bank:

Cash Inflow Examples:

  • Lockbox/Deposits: Deposits from checks or cash gained from sales
  • Wire transfers: Wire transfers from sources outside the organization
  • ACH: Deposits as a result of batch payments from clients
  • Borrowing: Any cash gained from short-term or long-term loans
  • FX: Cash obtained from differences in exchange rates

Cash Outflow Examples:

  • Payroll: Outflows as a result of paying employees
  • Account Payables: Outflows from paying vendors
  • Wires: Outflows via wire transfers to other bank partners or vendors
  • Debt Payment & Maturity: Outflows as a result of paying off debt
  • FX: Outflows as a result of losing cash due to a lower exchange rate

While these inflows and outflows are only examples, they provide an idea of the categories you may want to track your inflows and outflows on your cash flow forecast.

It is easy to track these sources of cash and outflows via automated cash management platforms, like Trovata, which utilize banking APIs and machine learning. These technological advancements help automate the aggregation and categorization of your bank transactions.

3. Calculate Cash Flow for the Period

There are various methods you can utilize to forecast your cash flow for any given period.

The most common forecasting method is the Naïve Forecasting method. The naïve approach is the most cost-effective forecasting model as it is produced based on historical bank data.

From your historical bank data, you can assume that cash flow will be similar to previous periods, especially if you are a business with regular, recurring revenue, like a B2B SaaS business.

For your forecast’s time period, whether you have your forecast broken down in weeks or months, you would take your forecasted inflows and subtract them from your forecasted outflows.

If you have a negative outflow, you won’t have enough money to pay your bills, and you may want to consider borrowing from your banking partners or asking your clients to pay you in advance at a discount. This way, you can be proactive and plan ahead instead of being reactive.

Simplify Your Cash Flow Forecasting Processes With An Automated Cash Management Platform 

You do not have to manage your data manually and create your forecasts from scratch. With Trovata, the next-gen, automated cash management platform, you can gain unified access to the richest banking information available from all your bank providers, empowering you to make better and quicker data-driven decisions.

By aggregating your cash and transaction data with open banking APIs, and collecting that data into a Multi-Bank Data Lake™, you can eliminate manual data entry and automate your cash reporting and forecasting.

Trovata makes it easier than ever to automate your cash forecast with its comprehensive suite of automated cash reporting and forecasting functionality powered by artificial intelligence and machine learning technology.

Through analyzing your organization’s historical data stored within the Multi-Bank Data Lake™, Trovata generates detailed forecasts that account for your historical data trends, which helps increase your forecast’s accuracy. Through forecast automation, you can enable your team to focus on strategic analysis that helps your organization make more informed, data-backed decisions.

Schedule a demo of Trovata and begin your digital transformation today!

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