Cash flow forecasting: What is it and why is it so important?

Every start-up aims to grow into a smooth-running, profitable company. No matter which stage of the business journey you are at, choices must be made to facilitate your agency’s direction of travel.

Being able to make informed decisions depends on understanding your firm’s financial position. That’s why a cash flow forecast is crucial to every strategic business move.

At de Jong Phillips, we provide advice and support, as well as insights into the latest and best cash flow forecasting technologies, so you can plan for the future and grow sustainably.

What is a cash flow forecast?

Your cash flow is the net amount of money transferred in and out of your company. Your cash inflow is the cash received, while investments or anything that is spent is classed as cash outflow.

Being able to determine the amounts, timing and (un)certainty of cash flow, as well as where the money comes from and goes to, are fundamental aims of financial reporting.

Precise cash flow forecasts can help:

  • determine if your agency is meeting performance targets
  • budget for investments or identify the need for loans
  • visualise the impact of planned changes in your agency

Why is cash forecasting important?

We’ve already established that an accurate cash flow forecast helps agencies make informed decisions, but let’s take a deeper look at exactly what that means.

Any choice about the business will depend on what financial resources are available. Nobody wants a negative cash flow.

Cash forecasting enables business owners to make informed decisions about their agency’s future, as well as their employees. 

Different methods of cash flow forecasting

There are several cash flow forecast methods. It’s likely that whichever you use works for your business – but the most common two types are direct and indirect forecasting.

Direct cash flow forecasting

This method essentially adds up all your agency’s cash inflows and deducts any cash outflows. The resulting figure is your company’s working capital.

Direct cash forecasting is usually the more accurate of the two forecasting methods. It’s also a good base for informed business decisions, as the calculations are based on actual cash flows and the time period covered is relatively short.

However, the further into the future the time frame moves, the less accurate this forecasting process becomes.

Indirect cash flow forecast

For a longer-term view, it’s better to use indirect cash flow forecasting methods. This method is based on forecasted income statements and balance sheets. This is ideal for financial planning insights into whether future growth strategies can be achieved.

Choosing a cash forecasting time period

No matter which method of cash flow forecasts you choose, the next step is to select a time period that your forecast will cover. That decision may depend on what you want to achieve with your cash flow projection. The following are some options you can consider…

Short-term liquidity planning

Ensuring your agency can meet immediate obligations through daily cash management.

Interest and debt reduction

Verifying there is enough liquidity in the agency to pay suppliers or meet loan or debt payments.

Covenant and key date visibility

Projecting the agency’s future cash levels for month-end, quarter or year reporting dates.

Liquidity risk management

Spotlighting potential future liquidity issues so there is time to address them.

Growth planning

Ensuring enough cash exists to support decisions or actions that will help increase revenues and net income.

After you have identified the reason behind your cash flow forecast, now you can choose the time period it will cover.

Short-term cash flow forecasts

Looking between 14 and 30 days ahead of real-time, these forecasts include daily breakdowns of payments and receipts.

The granular levels of data are ideal for short-term liquidity planning and helping an agency ensure its financial obligations are met.

Medium-term cash flow forecasts

This form of cash forecast looks at around 1 to 6 months ahead, though some can be up to a year.

The 13-week forecasts are the most popular and are widely used by agencies to support interest and debt reduction, as well as liquidity risk management and key date visibility.

Longer-term cash flow forecasts

Typically covering 6 months to a year and sometimes, even more, this forecasting period can be useful to determine future cash flows when planning long-term growth strategies or capital projects.

These forecasts can also be the starting point for your annual budgeting process.

Mixed-period forecasts

Agencies looking to avoid a negative cash flow figure can also create a forecast with multiple time periods.

For example, initially, weekly forecasts are issued for a 3-month period, before switching to monthly forecasts for the following 6 months.

What is included in a cash flow forecast?

Creating a cash flow forecast for your agency requires 3 key elements.

1.    Opening cash balance

First things first, it’s important to establish your agency’s most up-to-date cash position so you can determine how any forecasts will affect it – the aim is to have a positive cash flow figure. 

2.    Cash coming in

This includes actual income such as sales revenue, alongside any non-sales income or external funding such as tax refunds, grants, investments and any other financial sources. Add all the money up to determine your agency’s total inflows.

3.    Money going out

Now calculate cash transactions that are going in the opposite direction: salaries, rent, taxes, interest payments, loans and licence fees or investments. Don’t forget to include how much cash is paid for raw materials, marketing or other assets.

The difference between the total inflows and outflows is your net cash flow.

Building an accurate forecast

So, you’ve determined your cash position, the reason for your cash flow forecast and the specific period it’s going to cover.

The next step in planning your business finances is to gather and organise the relevant financial and historical data about all the cash inflows and outflows for the same period.

This information could come from multiple sources. For example; your bank, resource planning system and subsidiaries, as well as spreadsheets, investment plans, Accounts Receivable and Accounts Payable solutions and accounting software.

The pros and cons of cash flow forecasting 

There are many advantages for agencies basing their short and medium-term decision-making on cash flow planning. Let’s run through just a few.

1.    Facilitating strategic planning

Cash flow forecasting allows agencies to be more agile when it comes to strategic planning and sustainable growth.

A positive cash flow forecast can support decision-making that facilitates expansion and growth, while a negative cash flow forecast will prompt spending reductions or reallocation of resources. 

2.    Mitigate risk

Cash flow forecasting can provide a timely warning of possible challenges to future cash positions, either via trends or seasonal shifts.

It enables an agency to take proactive action to minimise or mitigate any risk or impact, setting the stage for a robust rebound. 

3.    Assess working capital

We know the difficulties of trying to predict accounts receivable and accounts payable, because they are subject to variables including customer behaviour, unpredictable project work or late payments.

However, identifying unpredictable or inefficient patterns enables practices that improve receivables and payables’ continuity to be implemented. That leads to better management of your current assets and liabilities, as well as more precise cash flow forecasting. 

4.    Monitoring outflows

Cash flow forecasting is the perfect moment to examine your agency’s spending and determine whether any changes need to be made to save more cash.

Reassessing your cash outflows could free up resources that can be deployed to support growth or investment strategies that will better serve your agency.

5.    Accelerate debt repayments 

Every agency should be able to meet bank payments and pay back loans or debts. Cash flow forecasting can help ensure that in future, cash is always available.

If an agency is under a debt covenant, cash flow forecasting can be used to make sure any minimum liquidity levels are maintained. 

Many lenders will attach ‘covenants’ to debts which are conditions that the borrower must meet. For example, the ratio of dents to assets may need to be at a certain level or profits must need to be at a certain level.

This is to give the lender comfort that the borrower can afford to roay the loan. if a covenant is breached, the borrower may recall the loan. These more exact estimates can also identify potential challenges that could result in a covenant breach. 

Technological cash flow forecasting solutions

The biggest challenge faced by agencies when it comes to cash flow forecasting is the sheer amount of work involved.

Thankfully, there are technological solutions that can streamline the cash flow forecasting process and enable agencies to grow and thrive.

Say hello to Float

Float is an online cash flow forecasting and management tool that offers real-time insights into your agency’s financial status. It allows you to make important decisions to help your agency grow sustainably, based on accurate financial data.

Among its features is the ability to include and exclude bank accounts, and offer cash flow projections from 30 days to 3 years.

Float allows you to change expected dates on invoices and bills, offers budget suggestions based on past data and provides budget vs actuals reporting. This means an agency can visualise the impact of unpaid invoices and bills and can compare more than two scenarios when planning.

As if that wasn’t enough, Float also automatically syncs with Xero to generate a live, rolling picture of your agency’s cash. Budgeting and forecasting become so streamlined that an agency can accurately plan for its future, at any time.

How we can help you

Our award-winning, tech-focused accountants spend every day supporting a wide variety of agencies aiming to maximise their resources and scale sustainably.

No matter what stage of the business journey you’re on, we can help you. Ours is a 100% Xero practice, and each member of our team is certified in the cloud accounting software.

It means that, alongside providing traditional accounting services, our depth of Xero knowledge and passion for tech-based solutions means we can put in place processes and systems that will ensure your agency runs like a well-oiled machine.

Your growth or investment decisions will be based on accurate cash flow forecasting, supported by our unrivalled accounting and business advisory expertise.

Our team will not only make sure you get the best out of Xero and the many apps that integrate with it, such as Float.

In helping you step back from the day-to-day, we’ll also ensure you stay on track to achieving your goals, via monthly performance reports and board-style meetings.

Get in touch and let’s get the ball rolling

Are you ready to take your start-up agency to the next level, or enable your established company to run so smoothly so you can focus more on being a leader? We can make it happen. Call us on 01372 708090, or alternatively, fill in this contact form and we’ll get back to you straight away. Let us help you start planning your long-term, sustainable growth today.