Top Tips for Accurate Cash Flow Forecasting

At Christmas time, the kings which we usually think of are the three men who bring present of gold, frankincense and myrrh to a newborn.

However, let’s not forget the other king who is not just for Christmas, CASH.

It’s long been said that “cash is king”, and can often be seen as a bit of a cliché. But 2020 has shown us the importance of understanding cash flow and being able to forecast it in the face of unprecedented levels of uncertainty.

Businesses who came into the pandemic with accurate, up to date, underlying financial data, were able to use this information to make informed, quick decisions about how they should be responding to the impact Lockdown and the various government support schemes.

Businesses with budgets and cash flow forecasts were able to apply for CBILS with limited additional effort.

Businesses with flexible cash flow forecasts were able to run different scenarios, such as moving in to heightened restrictions, to understand what effect they would have on their business and identify contingency plans to mitigate the impact.

This has driven an increase in demand from businesses to be able to quickly and accurately forecast their cash flow. The software providers have responded by improving existing products as well as new offerings being launched. It has never been easier to produce a cash flow forecast.

What do you need to think about when building a cash flow forecast?

  • There are two different types of cash flow forecast, Direct and Indirect. Direct cash flow forecasts use expected cash receipts and payments, often based on the underlying transactions your business makes, e.g. when invoices are expected to be paid by your customers. Indirect cash flow uses the budgeted profit and loss along with a number of assumptions about how long it will take for revenue and expenses to have an impact on cash. There are pros and cons of each approach, but generally direct cash flow forecasts are more accurate in the short term, whereas longer term forecasts would normally be based on the indirect approach.
  • Traditionally, cash flow forecasts were built using an excel model. Depending on the complexity of your business, this may still be the most cost effective way to look at your cash flow.
  • However, there are a number of products on the market which use either the direct or indirect approach to forecast cash. These apps will link to your accounting software and pull through the relevant data needed to start building your cash flow forecast, almost at the click of a button.
  • As the information in your cloud accounting software is the starting point of the forecast, it is critical that this is accurate and up to date, to provide meaningful data as a basis for your forecast.
  • Depending on the forecast software you are using, there are a variety of different ways that you can flex the forecasts for changes in assumptions, as well as building different scenarios (best/worst cases) and switching on/off a variety of decisions, such as opening/closing a new shop or buying a new piece of machinery. This will give you more information to factor in to the decisions you are making.

However, you decide to approach building a cash flow forecast, the key is to have something that is regularly updated and gives you the information you need to respond to the opportunities and challenges that 2021 will now doubt present.

If you have any questions or would like to discuss how you can get a better understanding of your cash flow, please contact your local MHA member firm.