Cash flow forecasting is the process of grabbing a crystal ball and asking it if you’ll come into a big windfall in the near future. Okay, not quite!
Cash forecasting is a process of estimating your cash inflows and outflows over a given period. Forecasting your cash is crucial for business health because it helps you anticipate your future cash position and avoid critical cash shortages. You can also use forecasting to know when to invest your extra cash and unlock additional earnings.
As a former forecasting consultant turned Trovata Solutions Engineer, I’ll cover some of the benefits you can glean from a robust cash forecasting system, tips for implementing one, and compare the different tools at your disposal.
What Is Cash Forecasting?
A cash flow forecast is a report that predicts your company’s future cash flows—it estimates how much money will come in and go out during a given period. An accurate forecast is like a cheat sheet for the future because it gives you the information you need to confidently make strategic decisions.
How is a Budget Different from a Cash Forecast?
Cash flow forecasting isn’t the same as budgeting. For one thing, the purpose is different: Whereas budgeting helps you plan your resources and capital for a project or business group, cash forecasting helps you manage cash efficiently.
For example, it can tell you if you’ll have enough reserves to pay down your debt and cover expenses without overdrawing an account.
Because they have different goals, budgets and cash forecasts include different information.
In a budget, you would include all the resources you need for a project or business section over a given time period—often a year. Budgets typically don’t separate out bank or cash movement.
In contrast, cash forecasts don’t tell you about the resources a given project will need—they tell you what you can expect your bank balances to be at different points in the future.
How Cash Forecasting Benefits Your Organization
Obtain a Clear Picture of Your Company’s Financial Health
An organization’s ability to manage its cash flow can make it either more resilient or more vulnerable to challenges.
For example, a robust cash flow forecasting model can help you identify early warning signs of potential financial trouble, like the inability to pay employee salaries. On the other hand, it could provide evidence that your company is well-positioned to start a new project or make new financial commitments.
Increase Awareness of Potential Business Risks
Clear visibility into your company’s future financial position can help you identify risks to your business, such as over-estimates of revenue or underestimates of expenses. Errors like these are common to some extent in business, but they could cause problems if you don’t anticipate them.
For example, weaker revenue than predicted could impact your ability to repay debts. Identifying the risks in advance can help you mitigate them. For example, you might choose to delay expansion or cut down on expenses.
Identify Potential Business Opportunities
Similarly, identifying cash surpluses helps you plan the best use for your money. You might invest in a new business project or leverage your cash to earn better returns. Your liquidity management decisions are more effective when you make them in advance based on accurate predictions.
Improve Access to Debt
Lenders often want to see that you have a clear picture of your future cash position before they agree to give your company a loan. Robust cash forecasts can help them feel confident lending you capital.
Manage Debt Better
Cash forecasting helps you plan debt better. First, it helps ensure you have cash available to make debt payments.
Second, it can help make sure that your company respects any financial restrictions placed on your company by your lender—for example, that you maintain a required minimum account balance.
Cash flow forecasts can play a critical role in helping you identify threats to those restrictions.
Experience More Predictable Growth
Many businesses grow through investment—in other words, through spending. Cash forecasts help companies plan their surpluses better so that they can grow in a more stable and predictable way.
Tips for Better Treasury Management and Forecasting
Just as cash flow forecasting is valuable when done well, poor forecasts can lead you to make ineffective business decisions.
Here are some tips for ensuring your forecasts are accurate and useful:
- Use accurate and current data. If you update your data manually, it could be prone to errors and quickly become out-of-date. In fact, IBM found that 88% of spreadsheets have at least one mistake. Avoid these errors by using open banking and bank APIs to automatically access your most recent cash data.
- Choose the right time frame. Short-term forecasts look ahead by 2-4 weeks and are typically better when day-to-day granularity is critical to meet financial obligations. Longer-term forecasts, like 13 week forecasts are better for preparing budgets and assessing long-term projects or growth strategies.
- Incorporate scenario planning. Unforeseen events such as COVID-19 have elevated scenario planning to be a must-have. Make sure to plan for a multitude of scenarios to be more proactive in assessing your capability to withstand disruption and the options you have to identify and respond to potential opportunities.
- Use powerful models. Treasury management technology is more advanced than it ever has been. AI and machine learning algorithms produce extremely accurate forecasts, so take advantage of these features for the best forecasts.
What Tools Exist for Cash Forecasting?
I won’t sugarcoat it, forecasting cash flow can be confusing. That’s why the majority of companies today don’t do it at all. The ones that do, tend to rely on Excel. Then, there are the few that use forecasting software to successfully reduce manual efforts and increase forecast accuracy.
Why You Shouldn’t Forecast Cash in Excel
When I was in consulting, I would build and manage cash flow forecasts for the firm’s clients. Most of my time I was digging through Excel data and analyzing cash flow trends. My goal was to come up with a cash flow forecast that made sense to management – all inside Excel.
Since most forecasts live in Excel, their owners are most likely average in Excel, at best. For most of us, learning Excel basics is achievable. But, as you scale, the level of expertise needed scales too.
Treasury needs a tool that has the flexibility of Excel, but without the learning curve.
Why You Should Opt for an Automated Cash Forecasting Tool
Here are some reasons why a purpose-built cash forecasting software will result in better and easier-to-generate forecasts than Excel:
1. More User-Friendly
Excel is a blank canvas, so you create whatever you want. This is great for an artist, but daunting for a treasury analyst.
Automated cash forecasting software makes this easier by limiting your choice of options, providing a more straightforward and simple user experience and less avenues for making mistakes.
2. Fast Scenario Planning
As mentioned previously, when COVID hit, treasury teams went into crisis mode. The name of the game was to preserve cash. While planning for something like COVID is impossible, teams that already forecast cash flow are able to react faster and make more informed decisions.
Automated cash forecasting software allows you to create and manage many scenarios – key to running a modern treasury team and being able to withstand adverse events.
3. Automated Variance Reporting
It’s one thing to make a guess. It’s another to get it right.
The most important, and ignored, area of cash forecasting is variance reporting. The reason: it’s time consuming. A forecasting software that can calculate these variances for you removes the excuse.
Variance reporting will make you better at forecasting cash flows. Don’t skip it.
4. ERP Integration
Integrations are tough to pull off. Luckily, there are ERPs out there making it easy for software to integrate ERP data into the forecast.
Consider a forecasting software that supports ERP data, like AR and AP aging details. This will further improve efficiency and reduce manual efforts in Excel.
5. Forecast Rollups
Things get tricky when you forecast cash flow for many entities or locations. In these situations, a lot of time goes into consolidating everything into one file. This means many tabs, mapping files together, and dealing with reference errors.
For all my decentralized companies with entities all over the place, this one’s for you.
With software like Trovata, you can create a forecast for each entity or location. Then, with a few button clicks, merge those forecasts into one clean view of your global cash flows – all in one place.
Smarter Cash Forecasting is Within Reach
No one said this was going to be easy! There are always hurdles when it comes to forecasting cash flow. Let’s get real here, the weather man isn’t always right either. Yet, there are things you can do to make your life a little less stressful.
Using software that works for your treasury team is the best thing you can do to reduce manual efforts. Trovata helps companies like Krispy Kreme and Block (formerly known as Square) to automate bank data aggregation and analysis, saving their team 40+ hours a month.
Spend less time on manual updates and more time making deliberate business decisions.