A cash flow forecast is a plan that provides information about how much money an organization expects to receive over a given time period, along with the amount expects to pay out over that same period. Companies usually begin to plan how much they expect to earn in sales and spend with their daily operational expenses with this report. A forecast will include funds that are expected from other sources, such as loans or grants, and one-time expected charges, like a real estate purchase.
Cash flow forecasts will not match a profit report because the latter is based on when the income occurs and when costs incur. The former provides information based on the receipt of the income and when paying for costs.
This tool can help a company to anticipate revenue shortfalls so that the financial roadmap remains simple to navigate. It can also help you to see when income levels might be higher so that the organization can prepare for expansion or focus on scalability.
The process of preparing this tool is more important than the details in the pros and cons of a cash flow statement, but there are still some specific points of interest to review.
List of the Pros of a Cash Flow Forecast
1. It provides foresight to organizational earnings.
When you create a cash flow statement, then you are creating an exercise that forces the leadership of an organization to look into their crystal ball of forecasting. This process adds up the sums expected from every revenue stream, and then it compares them to the total liabilities that should come from each expense category. It’s a comparison which provides useful data because it encourages everyone in the company to proactively seek additional funding if there is an awareness that earnings will be tight for a specific period.
The cash flow forecast will also help you to find times of surplus where you can start saving for the future when the financial cycle makes things tighter once again.
2. It can predict the state of your financial health.
When you have an excellent cash flow forecast at your disposal, then you can predict the state of your income as an organization at any given time. You can include your expenditures and assets as well to give a complete look at your overall financial health. It is even possible to factor in unexpected events in the modern statement, ranging from market disinterest to changes in political leverage. That means you can stay financially comfortable even if the worst-case scenario occurs.
3. This statement can help organizations plan for significant purchases.
Another one of the advantages to the cash flow forecast is that it will help an organization work out whether a significant expenditure can happen without creating too much risk to the financial health of the company. You’ll get to see what your current level of expenditures are against the future assets you anticipate having. This process allows you to calculate when new products could launch, when additional services are needed, or even when key leaders can step aside in retirement.
This forecast lets a company see when their income will be enough to create stabilization, and then show the C-Suite what needs to be done to accomplish that goal.
4. It can help an organization keep track of overdue payments.
A cash flow forecast helps you to understand the impact of possible outcomes and future plans. If you’re a small business owner, then this advantage can help you to keep track of the overdue payments that can occur. One late payment could lead to reduce liquidity almost immediately if you’re in the startup phase of an organization. This forecast can help you to model alternative scenarios that can help you to understand how different situations could impact your cash flow.
When you have insight into the customers who pay past your deadline, then you can have more control over the credit you extend in specific situations. A cash flow forecast gives you the option to test future scenarios to create a plan of action that will keep the revenues headed your way. It is an advantage that can provide peace of mind right away.
5. Cash flow forecasts help you to see if spending is on target.
Every business, no matter what its size might be, has revenue targets and goals that it wants to meet. Many of them tend to be time-sensitive as well. By taking the time to review a cash flow forecast, then it can help the leadership team, or a small business owner, understand when (or if) reaching those outcomes is possible. You’ll get to see the impact of your budgeting and how each line-item breaks down because of this advantage.
Cash flow forecasting gives you a tool that can help you to see the future of money movements into and out of the business. That means this option can help you to increase the accuracy of future budgets by taking a look at today’s behaviors.
6. It provides investors with an opportunity to review the financial health of a company.
Although bad data can influence the information in a cash flow forecast in adverse ways, investors will use this statement as a tool to determine the financial health of an organization. Most shareholders, especially in C-corps, are not involved with the daily operations of a company. This advantage lets them think of the business at a higher level, providing all stakeholders with more clarity about what the future should look like and what actions will be necessary to generate results.
The best cash flow forecasts will look at multiple outcomes, usually categorized as being the best-case scenario, an average result, and the worst-case scenario. There can be several choices between these three primary headings as well. This information makes it more of a straightforward process to see if new actions must be taken to ensure the survival of the company.
7. It provides additional options for governance.
The best organizations survive because they have excellent governance included as part of their company culture. There must be some level of accountability present at all levels in the chain-of-command for success to happen. A cash flow forecast provides the C-Suite and the board of Directors a tool that can hold someone’s feet to the fire, if necessary, to ensure compliance occurs.
This information is also vital to the continuing or additional investments of employees, investors, and others who create outcomes for the company. By knowing what is needed to accomplish a specific result, it is easier to plan out the steps that people can take to achieve the desired outcome.
8. This process can be automated with the right software.
There are several software tools available for businesses of any size to begin automating the processes needed to generate a cash flow forecast. Instead of crunching the numbers manually, the spreadsheets can disappear so that an organization can spend more time on other factors that help to grow the organization. You’ll spend less time producing this data as well, which will save some cash in the long run.
9. Cash flow forecasting makes it easier to see all of your options.
When you look through your crystal ball to create a cash flow forecast, then you can visualize any scenario that you think might happen with your business. This process can help you to reinforce the decisions that may need to happen in the future, like hiring more staff, changing your prices, or looking for a new supplier. This advantage can help you to know when an office upgrade becomes necessary or if you should be tendering for that big contract which just came your way.
10. It will improve the relationship management with an organization.
Cash flow forecasting allows you to create strong, but still flexible relationships with your suppliers. If these connections are mismanaged at any time, then it could cripple your liquidity unexpectedly. This information allows you to identity the partners that are critical to the health of your cash flow, giving you new opportunities to strength the bonds that you must have to remain successful.
Customer relationships are part of this advantage as well. Your forecasting can model specific outcomes based on price, repurchasing, and other factors that support the overall health of an organization. You’ll gain insights on what it takes to implement a culture of service in the company, creating added value that may improve loyalty while reducing turnover rates.
11. You’ll get the opportunity to focus on other tasks.
A cash flow forecast using automated tools allows you to simplify the processes involved so that more time and focus can go to the other tasks that require work. It takes just minutes to produce a statement when you have the vital figures available, including the production of graphical references that show the health of the company. With this data available upon request, larger businesses can build up their levels of investor confidence so that the leadership team can demonstrate their ability to manage in a responsible way.
List of the Cons of a Cash Flow Forecast
1. It can cause the C-Suite to lose their perspective.
When the leadership of an organization starts the preparation process for a cash flow forecast, then it can be easy to lose one’s perspective of the situation. When times are good, then it becomes natural to assume that everything will stay that way for the rest of the year. The cash flow planning will work with this assumption, making it a challenging to anticipate problematic changes that might occur.
Cash flow forecasts do not anticipate marketplace shifts, changing customer demands, or new problems that reduce the value proposition of the products or services offered.
2. There is unpredictability in business that cash flow forecasts don’t consider.
Even when you research the data carefully during the preparation of a cash flow forecast, there will always be circumstances or events that will influence the trajectory of an organization that fall outside of the control of the company’s leaders. Political changes, inflation, the price of raw materials, emergency maintenance or repairs, and other societal issues can all change the future of a company for better or worse ways. This option does not consider any of those future events.
Cash flow statements can make it so that it seems like you’ll know how or when turbulent events will unfold, but the odds are against an organization because of this disadvantage. Most forecasts provide evidence that things won’t turn out as planned.
3. It can provide an organization with a false sense of security.
One of the most significant disadvantages of a cash flow forecast is that it can create a dangerous illusion of financial security. This issue occurs because the leadership team is mapping out a scenario that encourages a healthy outcome. It is not unusual to be overly optimistic with this data, which can lead to excuses where productivity goes down or monitoring activities stop working as they should.
You must compare your cash flow forecast over time with real financial statements for each evaluation period to see how close your predictions are to reality. Then you’ll need to make adjustments to future projects based on the ongoing activities of the organization instead of only using the forecasts.
4. A cash flow forecast is only a rough estimate.
Most cash flow forecasts are usable for a small portion of the year. The goal is to use this information to see when loans or other types of finance might be necessary to fund company operations, but this statement is more of a rough estimate than anything else. It provides one possible future for the organization, but there are numerous other outcomes which might happen.
It can be helpful to plan for an unexpected payment, but this disadvantage also shows that some companies may not be able to see specific account payments through their crystal ball that could adversely impact the business in the future.
5. There is always a degree of probability involved with a forecast.
Cash flow forecasts always involve a certain degree of probability. This disadvantage is present no matter how valuable and accurate the internal data happens to be. That’s why most of the statements which include this information are short-term. As related to the above point, the probability of inaccuracy exists because this is an estimate. That means you’ll move farther away from 100% the further out you extend the prediction.
Think about how accurate a weather forecast tends to be. With modern computer modeling and individual experience, a 5-day forecast is accurate about 90% of the time. If you go out to a 7-day forecast, then the accuracy level drops to 80%. If you’re out at 10 days or longer, then the reliability of the information is about the same as a coin flip. Those percentages are similar to what you’ll experience with a forecast at the 1-month, 3-month, and 6-month levels.
6. It can lead to improper decisions from the leadership team.
Leaders who use a long-term cash flow forecast as the basis of their purchasing decisions can produce adverse results. An organization might decide to make a significant investment in new production equipment because there is a robust cash flow anticipated in the future. Then the improved output levels would create more revenues, allowing the company to push scalability. If there are unexpected changes to the cash flow, or the estimate Is flawed, then the decisions made could put unnecessary stress on the future financial health of the company.
7. Organizations must make assumptions to generate a forecast.
There are numerous assumptions that an organization must make when producing a cash flow forecast. You’ll need to predict future interest rates, inflation, tax laws, and growth to determine what will happen in the future. Even the “lifestyle” and “personality” of a company evolves over time, so forecasters must make assumptions about each element to produce data that becomes usable.
That’s why regular reviews are necessary with a cash flow forecast. You must update the assumptions that you use to ensure that the models are producing information that is as accurate as possible.
8. There must be some level of financial awareness for the information to be useful.
Knowledge of a current or future cash position is an essential data point for a business of any size. You must know how much liquidity you have at any time, under any scenario, to know what the organization must do to remain healthy. If someone does not have a financial background, then the information included with a cash flow forecast can seem overwhelming. This disadvantage becomes even more problematic if you’re using spreadsheets to generate the final statement instead of collaborative, cloud-based tools that explain the outcomes in simple language for everyone.
When you can understand what your situation with liquidity is at a glance, then you place yourself in a position where a prosperous future becomes more likely.
9. It can lead to tunnel vision.
A cash flow forecast can help you to answer the what-if questions that the future might hold for your business, but it can also cause some leaders to develop tunnel vision. If you’re the type of owner or leader that acts instinctively, then it is impossible to know if your success was maximized because there is no stress-testing of the choice. Your direction becomes uninformed because the data in the statement causes you to pursue one specific plan instead of looking at all of them.
This disadvantage can make it easier to leave money on the table. It can also cause some leadership teams to look at a poor choice as being the cost of doing business when they aren’t using a cash flow forecast appropriately.
10. A cash flow forecast doesn’t work without goals.
Many small businesses focus on getting through the end of the month without going under. It is not unusual for entrepreneurs and micro-businesses to take a weekly or daily approach to their survival. If you don’t have revenue goals to implement that are more than a passing thought, then a cash flow forecast will never produce something with intentional accuracy.
If you look at a clock in disrepair, it will tell the correct time twice per day. Broken or absent goals will create a similar result. You might think that you’re on the right path, but cherry picking your data without the presence of a goal will only lead you to failure.
Verdict on the Pros and Cons of a Cash Flow Forecast
A cash flow forecast can be a useful, short-term tool that helps organizations spot times of financial trouble so that lending products can be secured to provide assistance during that time. This statement can also spot the good times ahead, allowing companies to know when they can stash some liquidity away during an upswing in opportunities.
This statement will not be accurate if there is not a mutual understanding of the mission, vision, and goals of an organization. There must be an attitude in place that doesn’t accept excuses and requires ongoing reviews for this data to be useful.
The pros and cons of a cash flow forecast show that this information is useful when it becomes one of many tools used to look at the financial health of an organization. If it becomes the only statement that the leadership team reviews for decision-making purposes, then there could be money issues in the future that might cause some worry.
Although millions of people visit Brandon's blog each month, his path to success was not easy. Go here to read his incredible story, "From Disabled and $500k in Debt to a Pro Blogger with 5 Million Monthly Visitors." If you want to send Brandon a quick message, then visit his contact page here.