Cash flow forecasting is an integral part of business management, particularly for small businesses, since day-to-day cash and capital requirements are often not predictable. It helps a small business to make tactical and strategic decisions to achieve its long-term financial objectives.
Forecasting is a top-down approach to business planning that starts with the business’s overall strategy. A company’s board of directors and management team sets the company’s strategic objectives, which are then translated into performance targets for each business unit.
Cash flow forecasts can be simple, or they can be rather complex. They are typically structured around short-term forecasts (within the coming year), medium-term (within one to three years) and long-term forecasts (more than three years).
Forecasting takes combines past sales data, as well as current and future market trends. The estimates should be as precise as possible so that the business can make well-informed decisions about its future.
Here are the many benefits to forecasting your cash flow:
- Forecasting provides a picture of the company’s cash position. To make sound, strategic decisions, a company needs a complete picture of its cash position, including its breakeven, and cash surplus and cash deficit.
- Forecasting allows a business to see where extra investment can be made at the right time. A company can determine how much cash is needed to invest in expansion projects and make strategic decisions about them.
- Forecasting helps predict a cash shortfall. If a business makes an operating mistake and spends more than what was forecasted, it will know how extensive it will take to recover from the shortfall.
- Forecasting helps a company anticipate the money it will need at different points during the year. This makes it simpler to budget and manage finances. In addition, it helps you plan for your short-term cash requirements and enables you to manage your cash flow.
- Forecasting helps identify when to make an investment and when to avoid it. Moreover, it also helps companies determine the amount of cash it needs to generate to support their growth and profitability.
- Forecasting can help a business to take advantage of opportunities. If there is an opportunity to take advantage of a business opportunity that can be highly profitable, a company should act on it right away and forecast the cash flow.
- Forecasting helps a business predict their sales, which can help them identify risks, plan for contingencies and make strategic decisions. For example, if a company sees that they could have a cash shortfall in three to six months, they should avoid being late in payments to vendors and suppliers by issuing IOUs.
- Forecasting also helps businesses make strategic decisions about using their capital resources. For example, a company could borrow money or use internal cash or equity to finance its expansion projects. Alternatively, they could sell bonds or stock to raise external financing.
- Forecasting helps a business to do due diligence. For instance, if an investor was thinking about financing a project using a loan or equity from an external source, they could review past forecasts to determine the company’s performance.
- Forecasting aids in the planning process. It helps companies determine when to purchase equipment, build additional facilities and hire new employees.
Cash flow forecasting is an essential tool for most businesses. However, some companies may not need to do it because they forecast their cash flow based on their approval process and practices.
Conclusion
Cash flow forecasting is a valuable tool that helps you predict a business’s cash flow and keep track of the company’s financial performance. Forecasting isn’t an exact science, though. Many factors can affect a business’s cash flow, such as its customers, economic conditions, vendors, competition, and the like. Nevertheless, forecasting is an integral part of managing and keeping track of a business’s financial performance.
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