Cash Flow Forecasting: The Key to Making Smart Business Decisions

Running out of cash—tied with an inability to secure funding—is the No. 1 reason startups and small businesses fail. A 2023 Software Advice survey found that 56% of small businesses were denied funding—more than once—in the last two years due to poor cash flow. Cash flow forecasting can help avoid these issues by giving you a sense of how much money you have on hand to take on new projects, pay off debt on time, and meet your future funding needs. However, many small businesses lack guidance in this area, and nearly a third (32%) of small-business owners admit they need more help. With insights from Gartner research, we explain everything you need to know about cash flow forecasting. We also spoke with Catherine Hayes, operations director and head of finance at a digital marketing firm in the U.K., to get expert guidance and understand why cash flow forecasts are indispensable for small-business success.

Understanding Cash Flow Forecasting

A cash flow forecast estimates how much money will flow both in a business (e.g., from selling products or services) and out of it (e.g., from paying rent or purchasing assets). Cash flow is different from business income. It refers to liquid money—i.e., readily available cash that you can spend or invest. However, income also includes your business revenue from credit sales. By looking at past patterns, cash flow forecasts make guesses about future trends. Say, if your sales spike around the holidays, you can budget to buy more raw ingredients, or if winter is slow, you can plan to spend less. By serving as a diagnostic tool, cash flow forecasting helps uncover the root cause of your cash troubles. Discussed below are a few business situations where this practice helps.

Identify periods of low sales

Without adequate sales, you won’t be able to cover your operating expenses or invest in growth opportunities. By analyzing historical spend patterns, cash flow forecasting can identify periods where your projected expenses exceeded projected income. Visibility into periods of low sales and their causes (say, seasonal dips or significant expenditure) allows your business to come up with strategies to boost sales, such as launching a new marketing campaign or offering sales promotions.

Collect money faster

When customers owe you money but take a long time to pay, it can be tough to sustain operations. Cash flow forecasting allows you to visualize payment cycles and spot potential delays in receivables. This foresight can help you adapt your collection strategy by shortening payment terms, offering early payment discounts, etc. Hayes advises small businesses to be especially rigorous about collecting money in the early stages. “During this phase, your business loses more money in operations than it earns, so be almost paranoid about timely collections,” she suggests.

Prevent overspending

Escalating expenses—from material procurement to payroll—can quickly erode your financial stability. Cash flow forecasting helps you watch every dollar you spend by showcasing variances between forecasted spend and actual spend. This visibility enables opportunities to trim expenses without compromising quality and keeping a rein on your cash outflows.

Manage stocks better

Inventory sitting idle is a missed opportunity, while insufficient inventory can lead to customer dissatisfaction. Cash flow forecasting helps maintain the perfect balance in inventory control. By predicting how much inventory you’ll need based on what you usually sell, cash flow forecasting saves you from buying too much or too little.

Prepare for growth

As your small business grows, you’ll need more of everything—staff, inventory, resources—and faster than ever. But without adequate funds, growth will be challenging. Cash forecasting helps you continually reassess resource allocations, ensuring you pay off your liabilities and expenses on time and stay financially healthy to secure funds from creditors when you need them.

Choosing the Right Method

Based on your business needs, you have two options to create a cash flow projection: the direct method and the indirect method.

Method #1: Direct cash flow forecasting

The direct method includes counting every single dollar and cent you earn and spend. This means looking at all the money customers pay you and the money you pay for things such as salaries, rent, and supplies. The direct method is time-consuming but gives a detailed picture of cash movements and day-to-day liquidity.

How does it work? The direct method starts with an opening cash balance, to which cash inflow, such as customer collections, are added and from which cash outflow, such as payments made to suppliers, are subtracted to arrive at the total cash flow (i.e., cash on hand).

Best suited for: The direct method is best used to support short-term operational cash decisions, particularly when you’re planning a major project or program investment that requires careful budgeting. Since it delves into day-to-day trends and provides a detailed account of cash movements, it offers a granular view for managing cash flow more effectively.

Related Facts

• 56% of small businesses were denied funding due to poor cash flow (Software Advice survey).
• 32% of small business owners admit they need more help with cash flow forecasting.
• Running out of cash is the No. 1 reason startups and small businesses fail.

Key Takeaway

Cash flow forecasting is essential for small-business success as it provides insights into cash availability, helps identify periods of low sales, enables faster collections, prevents overspending, facilitates better inventory management, and prepares for growth. The direct method is best suited for short-term operational cash decisions, offering a detailed picture of cash movements and day-to-day liquidity.

Conclusion

In conclusion, cash flow forecasting is paramount for businesses looking to make smart and informed decisions. By accurately predicting future cash flows, businesses can avoid running out of cash, secure funding, and maintain financial stability. Whether through the direct method or the indirect method, cash flow forecasting provides the necessary visibility and control to effectively manage cash flow and ensure long-term success.