A guide to cash flow forecasting for small businesses

Cash flow forecasting is the process of estimating the cash inflows and outflows of a company in a given period of time. An accurate and rapid cash flow forecast equips a company with a preliminary knowledge of the financial position in the future. On the one hand, it avoids a serious cash shortage. On the other hand, it enables decision-makers to earn returns on cash surpluses they may have in the most proper way possible. 

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In September 2008, hundreds of well-suited employees walked out of one skyscraper on Wall Street, with boxes in their hands. The media cameras turned on them, ringing the death knell of Lehman Brothers, the fourth-largest investment bank in the US before the bankruptcy.

Lehman could technically reverse its miserable destiny with $639 million in assets and $613 million in debt, but because most assets are difficult to sell into liquid assets such as cash, it was running out of time quickly after only $1 billion cash left. 

The financial giant was eventually killed by cash flow problems.

But cash flow problems are more fatal to small businesses, especially startups, than to those titans of Wall Street, as they are more vulnerable to irregular economic situations and unwise business strategies due to their age and size. For example, Fast, a startup providing online checkout products failed fast after poor cash flow management. And according to recent research, 61% of the small businesses globally were struggling with cash flow, and nearly a third (32%) cannot pay vendors, pay back pending loans, or pay employees due to cash flow problems.

Read More: The Inevitable Fall of Fast

So what is the key for small businesses to avoid poor cash flow management and plan ahead for the future? Cash flow forecasting.

What is a cash flow forecast?

Before talking about cash flow forecasts, you need to know about cash flow first. The term cash flow refers to the net changes of cash and cash equivalents(CCE)  being transferred in and out of a company. Cash received represents inflows and cash given out represents outflows. 

Cash is often said to be the lifeblood of business, because like blood it flows through the body and keeps it alive. Simiarlily, in accounting terms, cash is the most liquid asset on the balance sheet, and the movement of the lifeblood is usually shown in a financial statement called a cash flow statement. Investors, board members and even the public (for those firms on the list) can see where the company’s cash position is, annually or quarterly. Do they have enough cash to pay off their debts? Do they have enough money to fund operating expenses? And do they have extra funds for investment and further development? All can be answered in the cash flow statement.

However, traditional cash flow statements cannot give you foresight. For founders, data predicting the future is much more useful than those historic numbers on financial statements. They need quick answers to questions like:

1. How much cash reserve should I have to cover possible debts?
2. Should I hire more and how many should I hire?
3. Which part of the business should I fund more and which part should I fund less?

These are the types of questions cash flow forecast models can answer. 

A cash flow forecast is the process of estimating the amount of cash in and out of a company in a given period of time. It offers founders a forward-looking view of how well the company generates cash from operating activities, investing activities and financing activities and how cash can be used to fund those activities:

1. Cash flow from operating activities 

Cash flow from operating activities, or operating cash flow, records money directly involved in the sales and production of goods or services, for example:

• Cash inflow: receipts from customers for selling goods
• Cash outflow: payments for purchases from suppliers; payments for operating expenses and tax expenses etc.

2. Cash flow from investing activities:

Cash flow from investing activities represents money gained or spent in investment-related activities such as: 

•  Cash inflow: sales of non-current assets such as equipment; sales of investments such as marketable securities; dividends received from stocks; interests received from bonds, etc.
•  Cash outflow: purchase of non-current assets and investment

3. Cash flow from financing activities

Cash flow from financing activities, or financing cash flow, describes the net flows of cash used to fund the company and its capital. 

• Cash inflow: proceeds from issuing equity securities, such as share stocks; proceeds from borrowing loans or issuing debt securities, such as bonds etc.
• Cash outflow: repurchase of equity securities issued; paying back of borrowing loans or redemption of debt securities issued; dividends paid for equity securities issued; interests paid for loans and/ or debt securities issued etc.

Among the three, cash flow from operating activities is closely related to the core business and provides the best opportunity to improve cash management of a company. Founders should also pay more attention to accounts receivable, accounts payable and inventories in order to improve cash management.

Why use a cash flow forecast?

Enough cash reserves can ensure liquidity and solvency, which are vital to a company’s survival in the short run. Meanwhile, a company should make use of spare money on reinvesting in the business, research and development and marketing, etc. if the company is on the rise. Founders can plan their business strategy ahead of time and make smart decisions with the help of a good cash flow forecast model.

Cash flow forecasts can:

1. Identify and plan for cash shortages: cash flow forecasts help you monitor your cash flow and ensure that you have enough cash to cover your short-term obligations such as the payment of salaries and other recurrent business expenses. 

2. Efficiently allocate cash surplus: cash flow forecasts help you manage available capital to fund investing activities that will boost the business. While it's reassuring to have large cash reserves, companies don't make money from it. Cash flow forecasts can help you recognise potential cash surpluses that you can use to support the growth of your business.

3. Test scenarios to answer “What-if” questions: cash flow forecasts enable you to project the possible impact of decision-making such as operating expenses and headcount changes. See how your decision may affect your company’s cash flow.

4. Manage your business expectations: By comparing your actual income and expenses with your forecasted income and expenses, you can see which areas of your business are over or underperforming. Therefore, you may change the business strategy accordingly.

However, it is often harder for small businesses to run cash flow forecasting models and manage cash flow on their own, as they lack the funds for a finance team (unlike larger companies). Some obstacles small business may face when trying to forecast cash flow include::

1. A waste of time: It is a time-consuming task to check spreadsheets and keep up with the constant changes in expenses such as hiring. Not to mention all the manual exporting and importing of data in spreadsheets. 
2. Errors from manual calculations. Human error is hard to avoid, but manually  importing data and calculations make the risk greater.
3. Lack of knowledge. At the most basic level, a cashflow forecast is just knowing how much money you owe and how much money you are owed, in a certain period of time. But doing it all in your head leads to inaccuracies and stress. Having the knowledge to make a good cashflow forecast over the course of more than 3 months takes more knowledge than many business owners have. 
4. Lack of guidance. Financial reports bring value only if you can understand them. Without a certain level of financial literacy, small business owners may need help from a professional to understand the results of their cash flow forecast.

A simple solution to curb these obstacles is a good Cash flow forecasting software. These kinds of software exist to help automate a lot of the work and can save finance teams or founders a huge amount of time and energy. 

Financial automation is the future. Automate your cash flow forecast with gini

Most entrepreneurs are experts in product, engineering or marketing - not finance. 82% of business failures are due to poor cash management. Stop spending hours trying to decipher your raw accounting data. Turn them into accurate and actionable pieces of financial insights by automating these processes. That’s why we created gini– we want to empower small businesses by providing the insights and tools that large corporations have. Get the help you need to manage your business spending and not run out of cash. 

Get access to a solution that uses real time financial data to help Founders make better decisions, share reports with their stakeholders, and access growth capital money more easily. Start your 14 day free trial of gini today.