Cash flow forecasting: How to manage your finances

1. Select your time frame carefully

Your objectives as a company dramatically alter the period of time your forecast should cover. When it comes to strategically managing your cash flow, time is always of the essence.

Are you short on cash and therefore worried about the day-to-day liquidity of your business? In that case, short-term forecasting is probably the most useful. But, if you’re planning to expand or pay off large amounts of debt then medium to long-term forecasting could help you time larger expenditures for when your business is cash rich.

As a rule of thumb, short-term forecasting extends between two to eight weeks. Medium-term forecasts cover up to six months, while long-term forecasts cover 6-12 months. Each of these options has its strengths and weaknesses. 

When choosing what period to cover in your projection, consider the following:

• Short-term forecasting is good for your business’s nitty-gritty payments and receipts but isn’t a useful tool when you’re planning for the future.
• Medium-term forecasting is great for planning toward key date visibility, such as quarterly reports, but lacks the scope for planning expansions.
• Long-term forecasting tends to be used for annual budgeting and forward planning. But little attention is given to the day-to-day inflows and outflows that affect a struggling business.

Finally, there’s also the option of performing a mixed forecast, which balance between future-facing visibility and day-to-day detail. One example of this would be a forecast that begins with a weekly overview to manage short-term liquidity risks, before moving on to monthly forecasts once the heat is off.

2. Gather data across all areas of your company

A reliable projection cannot be created if you don’t have accurate data about how much money you’re making and what you’re spending it on. Only when you have all the facts, can you make the necessary changes for your business to thrive.

Useful data for cash flow forecasting may include revenue from sales, operational expenses, one-off purchases, and debt repayments. Gathering it often requires input from various stakeholders and data sources within the company.

All of this information comes together to create an accurate representation of your free cash flow. It can also provide valuable insights into your business’s strengths and weaknesses. 

For example, if you find that your company’s inventory is increasing, you should include efforts to increase sales in your projection. Likewise, if your current sales are not generating as much profit as expected, maybe you should look into potential waste or inefficiencies that are hurting your bottom line.

3. Adapt to change

Let’s go back to our previous example, the company flooded with phone calls. Following the success of implementing IVR, productivity has gone up. But now there’s a new problem. Customer calls have increased exponentially, and they require more operators, more phones, and more office space. The problem? This expansion was not factored into your original forecast. 

Looking to solve this, you read an article about the value of VolP, or Voice over Internet Protocol. You now realize that by replacing your existing business phone system, employees can make or answer customer calls from any location using the internet.

But while VoIP may be a beneficial tool for your business, any new platform or investment will require major changes to your forecasting model.

Unfortunately, cash flow forecasting can be inflexible, because its predictions are based on data from previous months and years. This makes it short-sighted regarding both external changes and anticipating new challenges, such as changes to customer demand.

To avoid these shortfalls, try the following:

• Keep all your data as up-to-date as possible. This entails carrying out frequent stock takes or simply updating the forecast regularly.
• Constantly compare the forecast against your free cash flow. When discrepancies arise, ask yourself what changed, and what inaccuracies or unforeseeable events contributed to this gap between expectation and reality.
• Update your forecasting period to reflect your evolving situation. In the VoIP example, maybe a mixed forecast would help understand the short and medium-term impacts of the new strategy.