The Many Advantages Of Cash Flow Forecasting Explained
Let’s review the benefits of cash flow forecasting today.
Since all managers of small businesses. And big businesses too. Should understand the importance of a cash flow forecast.
And once understood. You will want to reap the advantages of cash flow analysis for your business. And right away!
So, no delays. It’s time to dive in…
Disclosure: At no cost to you, I may get commissions for purchases made through links in this post.
Benefits of Cash Flow Forecasting
As promised, here are 15 top benefits of producing a cash flow forecast for your business:
- Forces critical thinking
- Supports achievement of goals
- Provides a view into the future
- Indicates the health of your business
- Allows planning for different outcomes
- Provides insight into business operations
- Yields an internal communication tool
- Alerts when outside funds are needed
- Produces an external communication tool
- Indicates if surplus funds will be available
- Highlights overdue customer payments
- Allows planning for significant investments
- Keeps spending on target
- Identifies working capital needs
- Indicates business value
But before we review each one of these reasons for cash flow forecasting. In greater detail.
I first want to set the stage. With a couple of important foundation topics…
What Is A Cash Flow Forecast?
A cash flow forecast is a financial analysis. Formalized as a document or spreadsheet.
First of all, cash flow projections show the amount and sources of money coming into a business. Mainly from customers. But many other sources too.
Furthermore, the analysis shows cash flowing out. To pay all of the bills coming due.
Finally, the cash inflows and outflows produce an ending cash balance. For each period being analyzed.
How To Prepare A Cash Flow Forecast
The process of preparing a cash flow forecast is straightforward.
Since cash projections can be done in a few steps. Those steps are:
- Determine how far out you want to plan
- Select your period (day, week, month, etc.)
- Forecast cash flow of incoming money
- Estimate cash outflows
- Combine the information into a spreadsheet
- Review the estimates against actual results
Furthermore, there are many accounting software tools available. To automate the process of cash forecasting.
Okay. With those basics taken care of.
Next, let’s discuss each of the 15 pros of cash flow forecasting…
1. Cash Flow Forecasting Forces Critical Thinking
To prepare a cash flow forecast. A small business owner must think long and hard about business measurement.
And what actions they will take. Or not take. To move their business forward.
So, cash flow forecasting. Requires critical thinking about the future.
2. A Cash Flow Forecast Supports Achievement Of Business Goals
Setting company goals is an important part of business planning. And I’m sure you have goals for your business.
Thus, by thinking about the future. And putting that future into a cash analysis.
You will better understand if your goals are achievable. And if so, when.
The achievability of goals. And their timing for completion. Are 2 key aspects of business goal setting.
Let’s move onto the 3rd benefit. In our series of benefits of cash flow forecasting…
3. An Advantage of Cash Forecasts: Provides A View Into The Future
Whether your business is a hobby. Or, your life’s work. It is important to learn from the past.
But one thing is for sure. You can’t change what has already happened.
What you can change. Or put a better way, influence. Is the future.
And it is one of the perks of cash flow forecasting. Because it forces you to think forward and set goals. Days, weeks, months, or years in advance.
To understand what your business will become. And influence the results to your liking.
4. A Pro Of Cash Analysis: Indicates The Health Of Your Business
First of all, cash flow for a business is like the blood running through human veins. Because a healthy business has healthy positive cash flows.
Furthermore, positive cash flows can come in the form of internally generated funds. Most typical of mature, profitable businesses.
Or, positive cash flows can be provided by external sources. Either lenders or investors.
And if outsiders are willing to put cash in your business. That is a good sign.
On the other hand, there are cash flow problems. They can indicate a business is not so healthy.
And corrective steps must be taken. To return a business to a healthy state.
Here is another one of the advantages of cash flow forecasting…
5. Cash Forecasts Allow Planning For Different Outcomes
Different business decisions. Will yield different outcomes. Or, put another way, different business results.
So, make your business decisions come alive with cash forecasting. First, see the results of one course of action. Then, the outcomes of another way to go about running your business.
This process also goes by another name. It is referred to as scenario planning.
Looking at different options makes choosing the right path easier. It is a good reason to prepare a cash flow forecast.
6. Get Insight Into Business Operations From Cash Forecasting
Every business should operate as efficiently as possible. Either through internal processes. Or, by outsourcing critical tasks.
First of all, efficient operations cost less money to execute. Furthermore, efficiency services customers at a high level. Finally, productivity increases bottom line profits.
So, increase positive cash flows by being more efficient. And decrease the costs of running your business.
Because cash projections provide information about what business processes are going well. And which ones need to be improved.
This is another advantage of cash flow forecasting. Allowing you to see and then focus on the right things. To make data-driven business decisions.
7. A Cash Projection Is A Good Internal Communication Tool
Unless you are a one-man or one-woman operation. It is important to communicate the financial results of your business.
Communicate cash flows within your organization. And to your employees. The key people that run your business every day.
This way, you are not the only one. That benefits from the insight that a cash forecast provides.
So, share it with your employees. Congratulate them on a job well done. Or, highlight areas where improvements need to be made.
Thus, generate more positive cash flows. To share as higher employee compensation. And reinvest back in your business.
8. A Cash Budget Alerts When Outside Funds Are Needed
Sometimes it is necessary to go outside your business for cash. Either from investors or lenders.
This is most typical in early-stage companies. Growth companies. Any company that is planning to make a big investment. Or, a business temporarily going through some tough times.
Thus, a cash forecast will alert you in advance. That it is time to find a partner. Willing to invest in or lend to your business.
This leads me to the next benefit of cash flow forecasting…
9. Cash Forecasting Produces An External Communication Tool
When going outside your organization for money. You must put your best foot forward. And a cash flow statement is one great way to do so.
Because lenders need to know how you will pay their money back with interest. Also, investors will focus on earning a return on their investment.
And a cash flow forecast is an ideal way to communicate to these outsiders. Because cash is the primary language of business.
10. A Cash Budget Indicates If Surplus Funds Will Be Available
On the other hand, your business may be operating profitably. And generating excess funds.
If this is the case. Congratulations!
But do not get complacent. Since your cash flow forecast can alert you in advance. That excess funds are coming available.
This way you won’t let your money sit idly in the bank. You can put it to more productive uses.
Such as:
- Paying off debt
- Paying dividends
- Making new business investments
11. Cash Forecasting Highlights Overdue Payments From Customers
Service your customers at a high level. And deliver on the value you have promised.
But don’t let your customers take advantage of you. By being sure they pay on time.
And this is another one of the good things about cash flow forecasting. Because it provides timely information. When customers begin to pay slow.
Allowing you to contact them. When payments are past due.
Because realize this. Your customers are trying to maximize their cash flows too.
Just kindly let them know that your company is not a bank. And you expect to be paid on time.
12. A Benefit Of Cash Forecasts: Plan For Significant Investments
In business, there is an old saying. It is “it takes money, to make money”. Because it’s hard to get started or grow without making smart business investments.
And your cash flow forecasting process will help in this regard too. So plan all of your important business investments. Right into your cash analysis.
To ensure you have the funds to finance them. Then layer in the cash returns you expect to earn from these investments at a later date.
Solid planning for your business investments. It may be one of the most important benefits of cash flow forecasting.
13. Use A Cash Forecast To Keep Spending On Target
Every business should plan its spending. Just like every individual should have a budget.
And an additional benefit of a cash flow forecast. Is that it can also serve as a spending budget.
So, target your business’s cash payments in your projections. Then review your actual spending against the target.
Understand why you overspent. If you did. And what you can do about it. To improve the cash flow generating capacity of your business.
14. Cash Projections Identify Working Capital Needs
First of all, every business needs working capital to operate day-to-day. Furthermore, working capital is the investments in inventory, customer accounts receivable, cash for liquidity purposes, and other current assets.
Partially offset by the amounts owed to suppliers. And other current liabilities.
So, build estimates for working capital into your cash flow forecast. And never run short on these essential funds. Since they are required to operate your business in the short term.
15. Cash Forecasts Indicates The Value Of A Business
Most businesses have a goal to turn a profit every year. But there is another long-term aspect of running a business.
It is the value of your business. In the event, you choose to sell it to a 3rd party. And this is my last tip about the usefulness of cash flow forecast.
Because in one way or another, cash flows directly impact business value. And most businesses are valued on a multiple of current cash flows.
Or, a value is based on forecasted cash flows. Discounted back to present value.
So, a cash flow forecast has another benefit you may not have thought of. It is a business valuation tool.
Used to show the value of your business. To prospective buyers.
Okay now. That wraps up the 15 advantages of cash flow forecast.
Let’s finish with a recap…
Summary: Benefits of Cash Flow Forecasting
Here are the many uses of a cash flow forecast. 15 in total.
But, I’m sure there are a few more I haven’t thought of…
- Forces critical thinking
- Supports achievement of goals
- Provides a view into the future
- Indicates the health of your business
- Allows planning for different outcomes
- Provides insight into business operations
- Yields an internal communication tool
- Alerts when outside funds are needed
- Produces an external communication tool
- Indicates if surplus funds will be available
- Highlights overdue customer payments
- Allows planning for significant investments
- Keeps spending on target
- Identifies working capital needs
- Indicates business value
It’s time to get busy with your cash flow forecasting. Right away!
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- Best of our individual and business money articles
- How to set business goals
- Tips for improving your personal cash flow
Author Bio: Tom Scott founded the consulting and coaching firm Dividends Diversify, LLC. He leverages his expertise and decades of experience in goal setting, relocation assistance, and investing for long-term wealth to help clients reach their full potential.