Small business cash management can be complicated. If you want to be successful at cash management, you’ll need a skill called cash flow forecasting.
Revenue streams are never constant. Expenses go up and down. Busy periods come and go. Gathering and analyzing revenue data can help you measure the sustainability and liquidity of your company. It will also help you master cash flow forecasting.
What you need to know
- Cash flow statements look at historical data, while cash flow forecasting looks into the future.
- Your cash flow forecast shows sustainability if cash inflows are higher than cash outflows, but you should also account for inflation.
Understanding the basics of cash flow
Your cash flows can be reported on a cash flow statement (CFS) using a “direct” or “indirect” method of accounting. The direct method records actual incoming and outgoing cash. The indirect method uses accounts receivable and accounts payable balances. The Financial Accounting Standards Board (FASB) encourages the direct method.
The cash flow statement typically starts with a net earnings number taken from the income statement and then categorizes “cash flow from operations” into additions and subtractions. Examples of additions are increases in accounts payable and decreases in accounts receivable. An increase in inventory that incurs an expense would go under the “subtraction” category.
The additions and subtractions are summed to get a “net cash from operations” subtotal. The CFS then lists cash flow from “investing” and “financing.” Cash flows from investing activities include capital gains and dividends paid out. Financing activities are items such as business loans taken and business loan payments sent out.
Unlike the income statement, the cash flow statement cannot be easily manipulated by the timing of non-cash transactions. That accuracy is critical for cash flow forecasting. The net earnings on the income statement only affect the “operating activities” portion of the CFS, so they have nothing to do with the investing or financial activities.
Key components of a cash flow forecast
A cash flow statement is a historical financial data analysis, while cash flow forecasting is a look into the future. You’ll want to look at your cash inflows and outflows from previous reporting periods, then use historical data, accounts payable, and accounts receivable to determine how the next reporting period may go. A typical cash flow forecast contains the following:
- The forecasting period (month, quarter, year, etc.)
- List of expected cash inflows
- List of expected cash outflows
- Liquidity estimate (based on projected cash flow)
- Reconciliation and update schedule
There’s a difference between profit and cash flow. A retail company can show a gross profit on the balance sheet before subtracting operating expenses. Cash flow is the actual money coming in and going out. A cash flow forecast shows owners, shareholders, and investors how much liquidity the company has. That number is one of your business’ metrics of sustainability.
Techniques and tools for effective forecasting
Your income statement, balance sheet, and cash flow statement should be the first three documents you gather when preparing a cash flow forecast. You’ll also want an itemized expense report. This is a good time to look for areas where you can cut costs. You’ll also want to review the company budget to ensure short- and long-term liabilities are accounted for.
Traditionally, your cash flow forecast demonstrates sustainability if your cash inflows exceed your cash outflows. But recently, inflation makes that prediction somewhat unreliable. Modern “enhanced” cash flow projections don’t operate with that assumption. Instead, contingencies are built into the forecast to account for unforeseen economic shifts or market movement.
Using AI to do your calculations can save time, but be sure to check over the calculations yourself. You can also hire an accountant or bookkeeper to help you with cash flow forecasting. Don’t close yourself off to cash flow software solutions available in this area. Effective cash flow management tools, particularly expense management platforms, can make your job a lot easier.
Analyzing and interpreting cash flow data
Forecasting business trends is conjecture. Accounts receivable forecasting is a mathematical exercise that gets easier as you accumulate reporting periods. Unfortunately, anticipating business expenses can be more unpredictable. The costs of materials and supplies have been increasing, and sometimes emergencies happen. This makes financial planning and analysis more difficult.
Give yourself a margin of error when doing your cash flow forecast. Look back at previous forecasts to see what’s realistic. The current numbers are what they are. You can’t change them or guarantee they’ll hold steady over time. But you can plan for the worst-case scenario and hope for the best. For example, you can assume that inflation will be 3% next year based on last year’s rate, but use 4–5% rate in your projections to be safe.
A cash flow statement analysis can show you where you’re falling short. Cash flow forecasting is a more itemized approach that can be used to adjust pricing and cut costs in future reporting periods. This isn’t an exercise you do just once. Think of it as an ongoing financial risk assessment and strategic business plan. You can use it to make informed business decisions.
Tailored strategies for small businesses
Cash inflow and outflow management starts with accurately recording all transactions. You’ll want to evaluate your bookkeeping and expense management software to ensure they’re the best tools available for your business. Small business cash flow management is simpler when you have the right technology. It’s a good idea to schedule annual software reviews.
Adapt your forecasting techniques to the unique needs of your business. Retail businesses focus on the cost of goods sold (COGS). Manufacturers analyze the way they order materials and supplies. Analyzing and forecasting cash flows can provide insight into what to do if your business finances fall on hard times. Here are a few business sustainability strategies you might consider:
- Strategy 1: Implement robust invoicing and collections processes
- Strategy 2: Maintain a cash reserve for unforeseen expenses
- Strategy 3: Streamline operations to optimize cash flow
- Strategy 4: Do regular financial health check-ups
- Strategy 5: Leverage technology for efficient cash flow management
Risk management in cash flow forecasting
Incorporating some margin into your cash flow projections is one way to manage risk. Another is to do a cost analysis to ensure you’re not wasting funds on non-essential expenses. You’ll be pleasantly surprised (and maybe a little upset) when you see how much your company could save by adjusting how you spend money. An expense management tool can help with this.
Check your numbers several times and have someone else review them when you’re done. Accuracy is critical in cash flow forecasting. If your base numbers are wrong, your projections will be wrong. You can further mitigate this risk by using digital tools and accounting software that compiles reports based on transactions from your business checking account.
Conclusion
Learning to read a cash flow statement (CFS) is the first step to mastering cash flow forecasting. The CFS, income statement, and balance sheet are key documents to project future cash flow. Historical data from those reports can help you predict your revenue and expenses for the next reporting period. AR and AP numbers can also be used in that process.
Cash inflows and outflows constantly change over time, so business owners must analyze this data frequently to make informed business decisions. New techniques, like enhanced cash flow forecasting, provide a more efficient and agile approach. If you haven’t done so already, we encourage you to begin cash flow forecasting for your business.
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