What is a cash flow forecast?

A cash flow forecast estimates your future income and expenses over a set period. It shows how much cash you have, what your financial needs are, and how your balance will change. This process is also called cash flow forecasting or liquidity forecasting.

Forecasting equips business leaders to navigate uncertainty. By analyzing historical data, it enables informed predictions of future income and expenses across various scenarios.

Unlike budgeting, which remains static, cash flow forecasts are continually updated to reflect changing conditions. Forecasts typically cover three periods: short, medium, and long-term. What defines each?

1. Short-term cash flow forecast

The short-term cash flow forecast lets you gauge your company’s liquidity for the next few days or weeks. This way, you’ll always have enough cash at hand to cover operations – whether for payroll or bills.

Let's assume the forecast shows a big invoice is due in two weeks, but payments won't come in for three. You can plan ahead and secure extra funds to bridge the gap.

2. Mid-term cash flow forecast

A mid-term cash flow forecast typically spans three to six months, with a 13-week liquidity plan being especially common.

This forecast helps you make sound financial decisions – e.g., for making investments or taking loans. It shows early on whether you'll have enough cash in the coming months to make significant purchases or hire new staff.

For instance, if you plan to hire five employees in three months, the forecast will reveal if you have the funds, need financing, or must rethink your plans.

3. Long-term cash flow forecast

A long-term cash flow forecast looks ahead several years, typically up to five.

Its aim? Strategic planning and long-term investments. This tool helps you gauge your company’s future profitability and see if you can fund major projects, like expansions.

It also lets you evaluate whether entering new markets or countries within the next two years is feasible or if additional financing is needed.

By considering different time frames, a cash flow forecast shows how your liquidity is likely to evolve. While cash position and cash flow analysis tell you where you've been, a cash flow forecast helps you plan ahead.

Cash flow forecast: methods and approaches

Cash flow forecasting can vary depending on your timeframe, the precision you need, and the data at hand. Here are the most commonly used methods:

1. Direct method

• What it is: based on actual cash movements, using specific data on expected inflows and outflows to project future cash flow.
• When to use it: best for short-term forecasts (daily or weekly) as it offers a detailed view of liquidity.

2. Indirect method

• What it is: starts with net profit and adjusts for non-cash items like depreciation and amortization, using data from P&L statements and balance sheets.
• When to use it: ideal for medium- and long-term forecasts. While less precise for daily operations, it reflects broader company trends.

3. Rolling forecast

• What it is: continuously updates, extending the forecast by an additional period (e.g., a month) each cycle.
• When to use it: perfect for adapting to current data in medium- and long-term planning, keeping forecasts flexible.

Data approaches: Bottom-up vs. Top-down

Bottom-up: gathers detailed data, like daily cash positions, with close collaboration from departments supplying relevant information.

Top-down: relies on historical data and broad assumptions, using past invoices, budgets, and sales data to project future cash flow.

How to build a cash flow forecast

Start by defining your high-level goal – whether it’s achieving a specific revenue target, posting a profit, or something else entirely. Then use historical financial data as a foundation for future planning, but go further by critically examining the factors influencing the data. Consider elements like the macroeconomic climate or industry-specific conditions (e.g., seasonality). Beyond the most likely outcome, founders and finance leaders should anticipate potential upside and downside scenarios, along with the drivers that could impact them.

Here's how you can build a cash flow forecast step-by-step:

1. Define the time period

First, choose the forecast’s time frame. This can be short-term (days or weeks), medium-term (months), or long-term (years). This decision shapes the level of detail required in your data.

2. Gather historical and real-time data

Then you must collect data from your different bank accounts and transactions. Analyze all deposits and withdrawals, paying attention to their timing. With the right cash flow software in place, this is a walk in the park.

3. Assess revenue and customer data

Next, you compile all information on your revenue streams and your customer contracts to understand your income sources. You need to know where your money is coming from and in what frequency.

4. Calculate current cash flow

With the data gathered, you can determine your current cash flow status.

5. Project future cash flow

Based on the collected data, estimate how cash flow may evolve within your defined time frame.

6. Explore different scenarios

Develop various scenarios, optimistic and pessimistic outcomes, to understand how changing conditions might impact your cash flow and how they compare to your base case.

7. Regularly review and adjust

Continuously compare your forecast to actual figures, making adjustments as needed to improve accuracy.

Building a cash flow forecast is like a never-ending story. Don't see it as set in stone. It's flexible and dynamic, adapting as needed. Think of it as a guide to your cash flow in the coming months, not a rigid plan.

How often should you build a cash flow forecast?

While budgeting happens once per year, with forecasts it's different. Forecasting is crucial, especially in today’s unpredictable economy. It’s never too early to start. Even in the early stages of a company, regularly assessing progress against milestones is essential. Ask yourself: are we on track? Do we need to adjust our course?

However, forecasts are estimates, not guarantees. Whenever your outlook shifts, update your assumptions to understand their financial impact. The frequency of forecasting should align with the pace of change in your business. If your business is dynamic, updates should occur weekly or monthly. Conversely, stable businesses can rely on quarterly forecasts.

In some cases, more frequent updates are warranted. With certain companies, weekly or even daily metrics are necessary to gauge real-time performance. For businesses where payment volume directly affects revenue, daily or weekly data is critical. However, if your revenue stems solely from SaaS with longer sales cycles, weekly or monthly updates may suffice.

Why is a cash flow forecast important?

A cash flow forecast is essential for any business, irrespective of its current performance. It is a crucial tool for financial planning. A forecast allows you to address vital questions about your company's liquidity by reflecting on past performance and anticipating future needs.

While cash flow forecasting and liquidity planning are distinct, they are interdependent. Together, they play a pivotal role in everyday financial operations and strategic decision-making, regardless of the organization's size or structure.

The approach to creating a cash flow forecast varies based on your objectives. Understanding how this forecast can benefit your business is key to leveraging its full potential.

Creating financial reports

The primary aim of many financial reports is to forecast cash flow at specific intervals, such as the end of the month, quarter, or year.

Optimize cash management

Cash flow forecasts are integral to effective cash management. They help ensure sufficient liquidity by predicting cash inflows and outflows. For instance, you can anticipate when customer payments will arrive and when expenses are due. This foresight allows you to identify potential cash shortages or surpluses.

With this knowledge, you can optimize your cash position – investing surplus funds while addressing deficits by selling assets to prevent shortages.

Enhance strategic decision-making

A well-structured cash flow forecast enhances strategic decision-making. It enables you to project how your cash flow might evolve. This insight helps assess whether you can hire additional employees or make significant investments, allowing you to evaluate financial capacity and associated risks in advance.

Address key business questions

The cash flow forecast answers crucial questions about your liquidity:

• How much liquidity will be available in the upcoming days, weeks, or months?
• What impact will a business decision have on cash flow?
• Is cash flow likely to improve or decline?
• How will cash flow be affected if growth stagnates or decreases?
• What changes will occur if costs rise while sales remain constant?

Meet financial obligations

Forecasting cash flow is essential to ensure that your financial resources can meet obligations, ensuring smooth operations.

Financial and liquidity planning

Cash flow forecasts play a pivotal role in financial and liquidity planning. By analyzing historical data, real-time information, and your business plan, you can model future cash flows. This approach helps set realistic targets, allocate resources efficiently, and monitor outcomes.

Scenario planning

Use cash flow forecasts to develop various scenarios and analyze the impact of different assumptions. Compare baseline forecasts with best- and worst-case scenarios to determine how much liquidity is needed to create a financial buffer without generating an inefficient surplus.

Simulate stress tests

Assessing liquidity under pressure is crucial. A cash flow forecast allows for stress testing, simulating situations where revenue declines over several months or costs increase while revenue stays constant. This evaluation helps prepare for potential impacts on critical metrics, enabling timely and informed decision-making.

How re:cap enhances your cash flow forecast

With re:cap's Liquidity Forecast, generating cash flow forecasts is a seamless one-click process. We harness historical and real-time data from your bank accounts, enabling you to create accurate forecasts and monitor your cash flow trends effortlessly.

Our platform aggregates all your cash data while allowing you to manually adjust critical factors, such as revenue and cost projections. This lets you conduct stress tests, providing insights into your business's performance under pressure or during significant expenses. You can also evaluate how different financing options – debt or equity – impact your liquidity.

Additionally, re:cap's forecasting tool enhances your budget planning, helping you make informed financial decisions. Your cash flow forecast determines how much funding your business needs. If required, re:cap offers flexible debt funding to ensure you stay liquid in the months ahead.