Have you ever been surprised by a tax bill? What about budgeting—has your actual spending ever seemed pretty far off from what you anticipated? Or maybe you experienced a situation where you realized later that a surplus of cash should have been used to pay off debt, rather than purchase new equipment.
If you answered yes to any of these questions, it’s time to look more closely at your cash flow forecasting.
What is it? Cash flow forecasting is sort of a mirror to your cash flow statement. Rather than reporting on what has happened, as in a cash flow statement, it predicts how cash will flow in the future. It takes into account several elements:
· Anticipated payments from customers
· Your sales forecast
· Future capital expenditures
· Inventory purchases
With these four areas providing information, you can accurately determine how your cash flow might look in the future. While not foolproof, it does offer four key benefits that you will appreciate:
Tax Planning: By anticipating the revenue coming into your business, you can begin to set aside the amount needed to pay in for taxes. It will keep you from scrambling when your tax bill comes due and help you keep taxes in mind for future planning.
Debt Management: When you know cash is coming in, you can optimize your debt repayment without impacting your operational efficiency.
Distributions: Stakeholders love a profit distribution, but how do you know whether you can distribute profit without affecting your financial health? Cash flow forecasting can help.
Operational Savings: When there is a surplus of cash, you can save it to add a buffer against future uncertainty or to address areas like equipment repair as they occur.
Additional Considerations: Like any piece of financial information, there are limitations to the effectiveness of cash flow forecasting. For instance, a cash flow forecast developed in January will lose accuracy by a few months into the year. It may be helpful to establish monthly reporting and even weekly monitoring of changing factors that contribute to cash flow forecasting.
While there is risk in depending too heavily on cash flow forecasting, there is greater risk in not including it in your planning. Companies that don’t utilize it may find that they are prone to cash shortages or that their business decisions are not as informed as they should be.
At The Power CFO, we offer fractional CFO services designed to fit your business needs and your budget. Whether you need to refine your cash flow forecasting with improved accuracy or you need comprehensive financial reporting, contact us to discuss your options!
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