Is Your Cash Flow Forecast Complete?

What to consider when forecasting your company’s cash

Photo by JOHN TOWNER on Unsplash

“I admire any man who owns a castle, but it is harder to keep one” — paraphrased from Billions (Bobby Axelrod)

Companies need cash to operate. That’s the truth. Even non-profit companies need cash to perform their activities. But when it comes to this subject, the art isn’t in making money, but in keeping it. The only way you get to “keep your castle” is if you forecast your cash to:

1. Know how much investments can you make;
2. know when you need to look for the best sources of financing well in advance.

These are the two major reasons companies forecast their cash, which can be a very tedious and repetitive task to perform. After all, there are a lot of things to consider when peeking into the future, which is why the purpose of this post is to give you ideas as to what to look out for when forecasting.

The 3 Levels of Forecasting

To achieve this, we will explain the 3 Levels of Forecasting as you can see in the picture below:

The 3 Forecasting Levels

These 3 levels represent the variables that impact your cash flow forecast and should be considered depending of how far into the future are you peeking. Let’s look at the 3 levels in greater detail:

1. Level 1, The Cash Level: This 1st level represents cash flow forecasting between 1 week and 1 month. The variables that come into play here are mostly cash based (hence the name). What you should consider are mostly due (or soon to be due) invoices from clients and suppliers. You might also want to consider any other income or disbursements that don’t arise from invoices, such as contracts or other documents, to know what else is due that month;
2. Level 2, The Tendency Level: This 2nd level represents cash flow forecasting between 1 and 6 months. The variables that come into play here are your company’s tendencies. My suggestion would be to start with the P&L (sales, costs and expenses) and continue moving down the Balance Sheet. For example:

• How do sales behave in your forecasting time frame? Are there any unusual or seasonal changes?
• What are the recurring costs & expenses that occur during this timeframe? Are there any unusual or infrequent ones that are coming up (i.e. income tax payment, christmas bonuses, etc.)?
• How is you cash cycle going to behave (i.e. Cash Collection from accounts receivables, inventory rotation & purchasing and supplier payments)?
• Are there any programmed payments for fixed assets? Are there any tax payments to be made?
• What about other assets & liabilities (i.e. rent deposit, insurance payments, employee bonuses, etc.)?
• Are there any debt disbursements to be received or debt capital or interest payments to be made?
• Are equity partners going to invest more money into the company? Is the company going to pay shareholders dividends?

3. Level 3, The Macro (or external) Level: Finally, we arrive at level 3, where the forecasting timeframe becomes 6 to 12 months. Here, besides due invoices and tendencies, you need to look at what is going to happen outside your company in four basic areas:

• Rates: These can be interest, tax or exchange rates. Are there any foreseeable changes in the near future?
• Political & Fiscal Level: Is there any change in government? Is a new fiscal law going to be put in place?
• Inflation: Is there any foreseeable change happening to material & service prices (i.e. raw materials, rent, electricity, etc.); and
• Supply & Demand: What changes in client/supplier tendencies are happening and how will this affect your sales/cash?

Action Plan

These 3 levels can seem like a lot of work to take into consideration and I won’t beat around the bush…it is a lot of work. But if you are just starting out, your action plan should be to start from the first level and try to dominate it. Once you have the first level covered, then continue by increasing your forecasting time frame and analyzing all the other variables that come into play.

Final Suggestions

Three more things before wrapping up. One is to prepare for the worst and demand the best. If your Accounts Receivable manager says invoices will be collected in 60 days but historically you know that clients pay on average in 90 days, then forecast 90 days and demand your AR Manager to collect in 60 days.

The second suggestion is that, if you just don’t know which variable to pay attention to, then just prepare two scenarios, one best case and one worst case. Chances are you will land in the middle (hopefully).

Finally, don’t dwell too much on forecasting. Create the first version and adjust as you learn along the way. Your first cash flow forecast will probably have a lot of errors, but you can’t fix what hasn’t been created yet. Start now, polish later.

Giancarlo Jiménez is a Finance Professional with more than 11 years of experience in the field and more than 4 years of experience teaching about Corporate Finance in a Business School. If you want to organize your finance department, learn which mistakes to avoid when doing so and how to control your cash on a weekly and monthly basis, then sign up for a Free Video Seriesby clicking on this link.