How to create a cash flow forecast with accurate projections

Accurate cash flow projections help drive business success in today's hyper-competitive landscape. However, according to a recent Blackline survey, nearly half of finance professionals (49%) worry their cash flow data is unreliable.

Without a clear understanding of incoming and outgoing cash, companies are essentially flying blind and cannot make the most informed business decisions. Inaccurate cash flow data can skew a company’s cash flow projections, which have costly consequences:

• Overly optimistic forecasts may lead to overspending and ill-advised expansions.

• Underestimating cash flow can jeopardize payroll, vendor payments, and loan repayments.

In either case, the ripple effects can negatively impact relationships with stakeholders, damage credit ratings, and ultimately threaten the survival of the business.

To create accurate cash flow projections, finance leaders must base them on realistic assumptions and avoid the temptation of overly optimistic scenarios. This requires a deep understanding of your business, industry trends, and potential risks and opportunities. Further, scenario planning allows businesses to consider various outcomes and plan accordingly.

More accurate cash flow projections enable businesses to confidently navigate evolving market conditions and seize growth opportunities as they arise. This level of financial foresight can mean the difference between thriving and surviving in any economic climate.

So, what do you need to know about your business to create more reliable cash flow forecasts? For starters, the three main categories of cash flow: operating, investing, and financing activities.

• Operating activities comprise cash inflows from sales and cash outflows for expenses such as payroll, rent, utilities, and inventory. These core activities are often the most significant cash flow drivers.

• Investing activities involve the acquisition or selling of long-term assets, such as property, equipment, or investments. Cash outflows may include the purchase of new machinery or building a new facility, while cash inflows occur by selling assets or collecting principal payments on loans.

• Financing activities relate to the cash used to fund the business, including inflows from issuing stock or taking out loans, and outflows for repaying loans, making dividend payments, or repurchasing stock.

Additionally, you’ll want to have a deep understanding of your business's historical financial data. Analyzing past trends in sales, expenses, and other areas will help you identify seasonal fluctuations, growth rates, and additional factors that may impact future cash flows.

You’ll also want to be clear on how to execute the actual forecasting process. There are two main methods for cash flow forecasting: direct and indirect.

• The direct method involves projecting future cash inflows and outflows based on anticipated transactions, such as expected sales, projected expenses, and scheduled loan payments. This method provides a straightforward view of cash flow but can be time-consuming for larger organizations.

• The indirect method starts with net income from the income statement and adjusts for non-cash items, such as depreciation and changes in working capital. This method is typically more efficient for large enterprises but may provide less granular detail.

Ready to get to work on forecasting? Read on for a step-by-step guide to creating a reliable cash flow forecast.

Creating a cash flow forecast is just good business. An accurate forecast will help you improve budget management, better manage liquidity, identify potential shortfalls or surpluses, and make informed decisions. But the key word is “accurate.”

Here are eight steps you can take to get the most accurate cash forecasting for your business.

Step 1: Gather historical financial data

The foundation for an accurate cash flow forecast is built on historical financial data.

Such data serves as a reference point to help you identify trends, seasonal patterns, and growth rates that will inform your future projections. Begin by gathering comprehensive records of past performance, including sales data, expense reports, and bank statements.

Consolidating this information can help you efficiently analyze the data and extract insights that will shape the assumptions underlying your forecast. Accounting automation and spend management software can streamline the process of collecting and organizing this data.

Step 2: Forecast sales revenue

Several techniques can be used to project your future sales revenue. Analyzing historical sales trends and seasonal variations can provide valuable insights, while market research and a thorough examination of your sales pipeline can shed light on emerging opportunities and challenges.

However, realistic factors that may impact sales, such as planned marketing campaigns, competitor activity, and broader economic conditions, should also be considered. Failing to account for these variables can undermine the accuracy of your forecast.

To negate this risk, try developing multiple sales scenarios — optimistic, pessimistic, and most likely — allowing you to prepare for a range of potential outcomes. By incorporating these scenarios into your cash flow forecast, you'll gain a well-rounded perspective, enabling proactive risk management and informed decision-making.

Ultimately, forecasting sales revenue requires a delicate balance of quantitative analysis, market intelligence, and sound business judgment.

Step 3: Estimate operating expenses

Next, you’ll want to meticulously document the amount of cash leaving the building. Start by categorizing your expenses into groups, such as rent or mortgage payments, employee salaries and benefits, utilities, marketing and advertising costs, and other recurring expenditures.

You’ll also want to estimate future operating expenses, leveraging historical data as a baseline, but also accounting for planned cost increases due to inflation, new initiatives, or staffing changes. Consult department heads and review contracts and agreements to ensure all anticipated expenses are captured.

In doing this, you’ll also have an opportunity to identify potential cost savings. Critically examine your expenses to seek out ways to streamline processes, negotiate better rates, or implement cost-cutting measures.

By thoroughly evaluating operating expenses and proactively looking to optimize costs, you'll enhance the precision of your cash flow forecast and simultaneously foster a culture of fiscal responsibility within your organization.

Step 4: Project cash inflows from accounts receivable

Since outstanding accounts receivable, or customer debts, can significantly impact the timing of your cash inflows, it’s important to be able to predict when you’ll get paid.

Sometimes sales are recorded immediately, but the actual cash receipt lags behind. You’ll want to come up with a plan to project when those receivables will be collected.

Analyze historical collection patterns, taking into account factors like standard payment terms and any seasonal variations in customer behavior. Leverage this data to estimate future collections, recognizing that not all bills will be paid on time.

Additionally, consider strategies to accelerate collections, such as offering early payment discounts or tightening credit policies. These tactics can improve business cash flow and reduce the gap between a closed sale and cash receipt.

By accurately projecting cash inflows from accounts receivable, you'll gain visibility into your future liquidity.

Step 5: Forecast cash outflows for accounts payable

Just as customer payments impact your cash inflows, upcoming vendor payments (accounts payable) have a significant effect on your cash outflows. You’ll want to meticulously project these future payments to ensure the most accurate forecast.

Some steps you can take to optimize your accounts payable processes:

• Review outstanding purchase orders, contracts, and supplier payment terms to estimate when payments will be due.

• Analyze historical payment patterns and any seasonal variations in your accounts payable cycle.

• Negotiate favorable payment terms with vendors to extend payment windows, or arrange for installment plans to provide more financial flexibility.

Accounts payable automation software can help you gain more control over your expenditures and avoid potential cash shortfalls or overages. You’ll also get visibility that’s crucial for effective cash flow management.

Step 6: Consider capital expenditures and investments

Did you know that capital expenditures and investments in assets, such as equipment upgrades or property acquisitions, can significantly impact your cash flow projections? These one-time expenses often represent substantial cash outflows that must be accounted for in a forecast.

Carefully review any plans for upcoming capital investments and note the anticipated timing and costs associated with each project. Additionally, factor in any depreciation expenses that may result from these expenditures. Such non-cash expenses can affect your tax liabilities and profitability, influencing your overall cash position.

Step 7: Account for financing activities

Debt and equity financing are two ways a business can raise capital. Debt financing is typically a loan or other line of credit. Equity financing involves selling a stake or investment in the business. Both influence your organization's cash flow position.

When forecasting, you must account for any planned loan disbursements or equity investments, as these represent cash inflows. Conversely, factor in upcoming loan repayments, interest charges, and any potential future financing needs, which will impact your cash outflows.

Additionally, if your business distributes profits to shareholders or owners, be sure to include any planned dividends or distributions in your forecast.

Step 8: Use financial modeling tools

A financial modeling solution can improve the accuracy and flexibility of your projections. Such tools are designed to streamline complex calculations, automate formulas, and integrate data from multiple sources.

Scenario modeling and data visualization capabilities allow you to explore different business outcomes, enabling you to proactively identify potential risks and opportunities. Additionally, many financial modeling tools offer built-in templates and industry-specific functions, reducing the time and effort required to build your forecast.

For businesses seeking more bells and whistles, spend management platforms like Brex include cash flow forecasting modules, along with integrated expense management, automated bill pay, accounting, reporting, and analytics capabilities.

Access to a centralized and collaborative environment will augment your financial planning and analysis and help you make more informed decisions.

There are a few other ways you can improve the accuracy of your cash forecasting:

• Avoid overly optimistic estimates. It’s critical to base your assumptions on historical data, market trends, and expert insights.

• Regularly weigh performance vs. your forecast. Circumstances can change quickly, so don’t hesitate to use new information to update your projections.

• Stress-test your forecast. Modeling different economic scenarios, such as a recession, can identify potential vulnerabilities and help you develop contingency plans.

Creating a cash flow forecast grounded in reality is one of the most important success factors for a business.

It’s not a perfect science, but leveraging historical financial data, evaluating current expenses, and estimating future cash inflows and outflows will help you build a forecast you can count on. You’ll have a working forecast that you can continue to hone as circumstances change.

Looking for help getting started? See a demo to learn how Brex can help you create more accurate cash flow forecasts.