Cash Flow Forecasting Best Practices: What You Need to Know

If you’re looking to gain critical insights into where your business’s finances are headed, our cash flow forecasting best practices will help you do just that.

Much like a ship relies on its captain to navigate treacherous waters and ensure smooth sailing, a business counts on cash flow forecasting to identify risks and better plan for the future.  

The benefits of a cash flow forecast are many. It enables you to predict your business's financial future so you can plan for cash shortages, make the most of cash surpluses and measure performance against plans.

With the right cash flow analysis tools, you can work out if you need to reduce expenses or focus more time on generating sales. You can even see how specific changes – like launching a new product or entering a new market – will impact your finances.  

In this guide, we share the most useful cash flow forecasting best practices to help you get started. You’ll learn about the essential factors to consider when forecasting sales and tracking expenses, as well as how cash flow forecasting tools can simplify the process.  

What is the purpose of a cash flow forecast?

Let’s first start with the definition of cash flow forecasting. Put simply, it’s a financial process that allows businesses to project future cash inflows, outflows and balances over a specified period.

This entails estimating future sales and expenses as well as accounts receivable and accounts payable figures. Cash flow forecasts can focus on a future period ranging from the upcoming month to the next 12 months and beyond.

The purpose of a cash flow forecast is to provide a snapshot of your business’s future liquidity to anticipate cash movements and make better strategic decisions. It helps businesses avoid cash shortfalls, honour debt obligations and wisely invest cash surpluses.

In short, forecasting allows you to enhance future operations, look out for potential pitfalls and plan your business’s growth.

4 components of a cash flow forecast

A comprehensive cash flow forecast typically includes the following fundamental components:  

1. Opening cash balance

The opening cash balance reflects the initial amount of cash available at the beginning of the forecast period. This figure reflects your bank balance, whether positive or negative, and serves as the foundation for your cash flow projections.

2. Cash inflows

Cash inflows refer to the money expected to enter your business during the forecast period from a range of sources, including from sales, loans, dividends, tax refunds, corporate funding or rental income.

This component of cash flow forecasting involves projecting how much cash you will receive from each source, as well as when you will receive it. Historic financial and sales data, as well as analysis of market trends, customer behaviour and seasonal fluctuations can be used to inform estimates.  

3. Cash outflows

Cash outflows cover the expected expenses and payments exiting your business throughout the forecast period. These can include expenditures like salaries, rent, utilities, taxes, loan repayments, bank charges and interest payments.

It’s important to work out the amount you are likely to spend on these expenses and payments, and when you will need to do so. Invoices, payroll records, payment deadlines and supplier agreements can all be used to inform your projections.

4. Closing cash balance

The closing cash balance provides a view of whether your business has a cash surplus or deficit at the end of the forecast period. This involves adding net cash flow to your opening balance, which will reveal the residual amount of cash available.

With this figure, you gain a snapshot of your business’s financial health to help identify potential cash flow challenges and assess profitability. It also forms the opening cash balance for your next forecasting period.

Best practices for cash flow forecasting

Getting the most accurate results and fully reaping the benefits of cash flow forecasting requires factoring in multiple variables. This includes sales projections, expenses, as well as payments your business owes, and those owed to you, during the forecast period.  

Let’s look at how you can best capture this data and integrate it into your cashflow forecast.

1. Performing accurate forecasting

Forecasting involves estimating your business’s expected revenue over a specified period. In simple terms, it helps you predict how mucha business will sell and when.  

Forecasting means analysing a range of data concerning historic sales, market and industry conditions, customer behaviour and your current pipeline. It allows you to establish realistic sales goals, optimise inventory, effectively allocate resources and align business strategy with market demands.

To enhance your cash flow forecasting, consider implementing the following best practices:  

a) Ensure data integrity

Clean and comprehensive data is essential for accurate forecasting. If you’re a smaller business, you may even rely on data managed in spreadsheets.

Keeping data up-to-date and accurate across all these systems is the responsibility of everyone in your organisation – from sales reps to business leaders. Clearly communicating a culture of data hygiene and establishing robust data standards can help improve data entry practices and ensure regular updates.

You may want to appoint key people within your business to ensure data standards are applied and regular data reviews take place across different teams. All these long-term efforts will ensure your data will provide an accurate picture of the future.

b) Select the right forecasting method

There are a range of methods commonly used by businesses to forecast effectively. Each method has its own advantages and limitations, and choosing the right one depends on your business’s goals, available data and resources. Popular methods include:

• Direct forecasting: Predicts future values of a variable directly based on historical data to help determine short-term trends.  

• Indirect forecasting: Generally part of the planning and budgeting process, this long-term forecasting method can help determine broader strategic planning.  

c). Account for internal and external factors

While your historical data can lend insights into business trends, it may miss potential factors outside of its scope. It’s important to factor in changes that may not be captured in data and will impact future business trends, including those related to:

• People and policies: New hires or layoffs can divert attention from pursuing prospects, while updates to commission structures or pricing strategies can impact sales performance.
• Market expansion: Venturing into new territories or industries can significantly alter your business dynamics. New markets often demand increased efforts for customer acquisition, potentially prolonging cash flow cycles.
  
• Product and services: New features, plans or products can disrupt cash flow forecasts by influencing customer demand and behaviour. Even subtle tweaks to product offerings or pricing models can have profound ramifications on your cash flow.
  
• The economy: Fluctuating inflation, the possibility of recession or global supply chain issues can change market dynamics and customer purchasing behaviour.
  
• Industry dynamics: Fresh competitors entering your industry, new technology or changes to the supply of materials can all alter customer preferences and behaviors.  

d). Regularly review and update forecasts

Cash flow forecasts should not be static documents but dynamic tools that evolve with changing market conditions and business dynamics. It’s important to establish a regular cadence for reviewing and updating forecasts, ideally on a monthly basis. This will help ensure forecasts remain relevant and aligned with current performance and market trends.

2. Ensure detailed expense tracking

Expense tracking is fundamental to gaining visibility of your cash outflows, thereby allowing you to accurately forecast cash flow. This calls for a robust system to keep track of expenses including:

• Operational expenses: The day-to-day expenditures necessary for running the business, like utilities, rent, payroll, office supplies and marketing expenses.
  
• Capital expenditures: Investments in assets that provide long-term value to the business, such as equipment purchases, property acquisitions or infrastructure upgrades.  
  
• Debt payments: Interest payments and principal repayments on loans or lines of credit.  
  
• Cost of goods sold (COGS): The direct costs of producing goods or services sold by the business, including the likes of raw materials and production overheads.

Tips to help you keep on top of these expenses include:

• Making use of accounting software that streamlines the process of recording and monitoring expenses.
  
• Regularly analysing historical spending data to identify trends and patterns over time.  
  
• Creating distinct categories for different types of expenses, such as operating costs, marketing expenses, salaries and utilities.
  
• Implementing a receipt management system that allows employees to digitise receipts using mobile apps or scanners.  
  

3. Managing accounts receivable and accounts payable

To ensure accurate cash flow forecasting, it’s important to effectively manage all the payments owed to your business and those you owe to others. This involves factoring in the following accounts receivable and accounts payable considerations:

• Customer payment terms: The terms you offer customers that can impact the timing of cash inflows. This includes payment due dates, discounts for early payment and billing cycles.
  
• Supplier agreements: The payment terms you have negotiated with suppliers can affect the timing of cash outflows.  
  
• Outstanding payments: The customer payments that have not been paid by the due date that need to be chased up in the forecasting period, as well as those you may owe to suppliers or other parties.

Tips for improving accounts receivable and accounts payable management include:

• Sending invoices as soon as a product or service is provided to the customer, with payment terms clearly outlined.
• Offering multiple payment options to make it easier for customers to pay.
• Establishing a routine of regularly monitoring the payments owed to you.
• Keeping track of accounts receivable KPIs like Days Sales Outstanding and Average Days Delinquent, ensuring they are maintained at optimal levels.
• Setting credit policies that offer favourable payment terms to customers with good credit ratings, and stricter terms to those with poorer ratings.
• Reviewing aging accounts to ensure there are no outstanding payments.
• Creating a follow-up procedure for chasing late payments.
• Speaking to suppliers to negotiate longer payment terms.

Creating multiple scenarios

Once you have created your cash flow forecast, you can start experimenting with scenario forecasting. This technique involves amending your base level forecast by factoring in different underlying assumptions about future business performance, decisions, initiatives or possible upcoming events.  

For example, with the help of cash flow forecasting software, you can create a scenario that factors in expanding into a new territory or launching a new product. You can also create best or worst-case scenarios based on your base level forecast.  For instance, a scenario where you assume higher sales and lower expenses.

You can also create scenarios to assess the impact of external influences, like an economic recession, supply chain disruption or the introduction of new technology into your industry.  

Tools and technologies for cash flow forecasting

From spreadsheets to sophisticated cash flow forecasting software, there are a range of tools readily available to perform forecasting. Let’s look at some of the most widely used.

The pros and cons of spreadsheets

Given their flexibility and familiarity for most people, spreadsheets like Excel are an effective tool for basic cash flow forecasting. You can customise spreadsheets as you see fit, and they make it easy to enter and manipulate data. However, with this simplicity comes drawbacks.

Creating a cash flow forecast in a spreadsheet will require significant time and effort, taking anywhere from hours to days. You will also need to manually manipulate data whenever there’s a change to business circumstances, plus the lack of sophistication of spreadsheets means figures and calculations may include errors.

Cash flow forecasting software

Software for cash flow forecasting  like Fathom can provide more sophisticated functionality to create detailed cash flow projections, analyse various scenarios and generate visually appealing reports with ease.

Fathom offers several advantages over traditional spreadsheet-based forecasting methods:  

• Automated updates: Unlike static spreadsheets, Fathom automatically updates your cash flow forecast as your financials change.  
  
• Clear and actionable insights: Visualisations help you understand where your cash has gone and assess the quality, sustainability and fluctuations of your cash flow.
  
• Accuracy: You can trace the source of every figure in your forecast to ensure accurate and reliable projections.
  
• Flexibility: You can easily customise cash flow forecasts to account for various possibilities and changes with features like scenario planning.
  
• Advanced reporting: Comprehensive reporting capabilities make it easy to perform a variance analysis between actuals and your forecast.
  
• Integration: Fathom seamlessly pulls data from your accounting software, offering integration with the likes of Xero, Quickbooks and MYOB.
  
• Collaboration: Multiple users can work on cash flow forecasts simultaneously, eliminating the need for multiple versions of the same file.

You can gain an idea of how easily you can customise a cash flow forecast with Fathom in the video below.  

Recap of takeaways

Cash flow forecasting is a powerful tool to help your business plan for potential cash shortages and identify areas where you can really move the needle in terms of financial performance.  

To truly get the most out of forecasting and simplify the process, make sure to:

• Structure your forecast around the four fundamental components – opening cash balance, cash inflows, cash outflows and closing cash balance.
• Create a robust system to forecast sales that ensures it is based on complete and accurate data, utilises the forecasting method best suited to your goals, and accounts for factors not captured in your data.
• Continually monitor cash outflows from operational, capital, debt and cost of goods sold expenses.
• Factor in all the cash you will owe, and that owed to you, during the forecasting period, and implement measures to ensure you get paid faster.
• Experiment with different forecasting scenarios to see the impact of specific variables, like increased sales, new product launches or economic conditions.
• Consider how cash flow forecasting tools can help you save time, automate the process and quickly implement the best practices we’ve shared. ‍

How you can start building your cash flow forecast today

If you want to avoid the complexities and limitations of spreadsheets, why not see how you can simplify cash flow forecasting with a free 14-day trial of Fathom? Test out its features for yourself and see why it's trusted by over 80,000 businesses worldwide.

Fathom is designed with specific cash flow forecasting functionality that allows you to visualise your planning, test different scenarios and forecast up to five years into the future.

Live forecasts mean you’ll never have to worry that your data is out of date, and you can even create multiple forecasts for your different business units or departments.  

You can discover more about Fathom’s cash flow forecasting features in our help centre, while our blog contains a range of tutorial webinars and customer stories to explore.

Two of our most popular introductory webinars include our cash flow forecasting overviews for businesses and accountants.

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