6 Common Mistakes of Cash Flow Forecasting
If you’re in business, then you know that cash is king. But what happens when you don’t have a clear understanding of what cash flow is? This can lead to some serious problems down the road.
Maintaining a positive cash flow is one of the most important aspects of running a successful business. This can be a challenging task of bookkeeping for small businesses, especially if you don’t have a clear picture of your incoming and outgoing funds. A cash flow forecast can give you this visibility, but only if it’s done correctly. Unfortunately, there are a number of common mistakes that businesses make when creating their cash flow forecast.
In this blog post, we will explore some of these mistakes and how to avoid them. By doing so, you can overcome challenges related to cash flow forecast and ensure it is accurate and helpful for managing your business finances.
Cash flow forecasting: 6 common mistakes and how to avoid them
- Misclassifying the three cash flow activities:
The most common cash flow forecasting mistake is misclassifying the various cash flow activities. For creating an accurate cash flow forecast it is essential to understand the difference between operating, investing, and financing activities.
Operating activities are the day-to-day operations of your business, such as selling products or services, incurring expenses, and collecting receivables. Investing activities are long-term investments, such as purchasing equipment or real estate. Financing activities involve issuing equity or debt, repaying loans, and distributing dividends.
Once you’ve categorized your activities, you need to estimate the amount of cash that will flow in and out during each period. This can be tricky, especially if you’re forecasting for a period of time in which your business is expected to grow rapidly. In general, it’s best to err on the side of caution when estimating inflows and outflows.
After you’ve estimated your cash inflows and outflows, you need to create a schedule detailing when each transaction will occur. This is important because timing can have a significant impact on your business’s cash flow. For example, if you’re expecting a large influx of cash from a new customer but the payment doesn’t arrive until after you’ve already made several large purchases, you will suffer cash flow problems eventually.
2. Underestimating fixed costs
In business, there are certain costs that remain fixed, no matter how much or how little business is conducted. These costs are called fixed costs. Fixed costs can include items like rent, insurance, and equipment leases. Oftentimes, business owners underestimate the impact of fixed costs on their bottom line, which can lead to financial trouble.
It is important for business owners to understand and account for their fixed costs, especially as they plan for future growth. Ignoring or underestimating these costs can be disastrous for a company. By planning for and budgeting for fixed costs, business owners can ensure that their company remains profitable and sustainable.
3. Overestimating sales:
Most business owners tend to overestimate sales since they become overly enthusiastic about the prospect of a new project or a new client and start to envision much higher revenue than is actually expected.
It is important to be realistic about your sales figures and to have a good understanding of your market and your customers. When you overestimate your sales, you run the risk of setting your expectations too high and then being disappointed when you don’t meet them.
Being cautious in your estimations is one approach to prevent this. Always take a fair margin of error into account when estimating how likely a sale is.
Another way to avoid overestimating your sales is to track your progress over time. Keep track of your actual sales figures, and compare them to your estimates. This will give you a good idea of how accurate your estimates are, and it will help you to adjust your estimates accordingly.
The bottom line is that you should never assume that your sales are going to be higher than they actually are. Be realistic about your figures, and you’ll be much more likely to achieve your targets.
4. Failing to take into account changes in seasonality
Failing to take into account changes in seasonality or other factors that could impact your cash flow can be a big mistake and can lead to cash flow problems down the road.
What is seasonality? Seasonality is the change in demand for a product or service that happens at the same time every year. For businesses, this could be things like increased demand for air conditioning services in the summer or increased demand for Christmas lights and decorations in the winter.
If you don’t take seasonality into account when forecasting your cash flow, you could end up in a tight spot. That’s because your forecasts will be based on an average of data from all 12 months, rather than data that reflects the actual ebb and flow of demand throughout the year.
To avoid this, make sure to take seasonality into account when forecasting your cash flow. This way, you can be prepared for the ups and downs of demand and avoid any cash flow problems.
5. Not taking into account cash inflows and outflows:
Not taking into account cash inflows and outflows is the most common bookkeeping mistakes made by small businesses. It can lead to inaccurate financial statements and an incorrect understanding of a company’s financial health. In order to make sound financial decisions, it is important to have an accurate picture of a company’s financial position. This can be done by taking into account all cash inflows and outflows.
6. Not revisiting forecasts regularly:
Forecasting is an important part of business, but it’s not something that can be done once and then forgotten about. The key to estimating future cash flow is to revisit your historical cash flow. Forecasts need to be revisited on a regular basis to account for changes in the market and the business. If forecasts aren’t revisited, they can lead to a false sense of security and quickly become inaccurate and lead to bad decision-making.
Thanks for reading! We hope this blog post has helped you understand the five most common cash flow forecasting mistakes, and how to avoid them. IBN Tech is an industry expert well-versed in helping businesses with cash flow forecasting processes. For more information on cash flow forecasting or any other bookkeeping and accounting-related services, please contact us.
