5 Common Obstacles to Accurate Cash Flow Forecasting
Every business requires financial momentum to create growth– meaning that a reasonable prediction of future income and expenses is essential to survival. Your cash flow forecast informs spending limits, sales goals, and opportunities to gain additional capital through investors.Download NowWatch Now
Money is constantly flowing in and out of your business– and with payment plans and recurring subscriptions, you’re often working with money that isn’t in your business account. So having accurate cash flow forecasts determines your company’s survival.
Unfortunately, lack of cash is one of the top contributors to business failure, particularly for startups. So, where do company leadership and finance employees commonly face challenges? And how can companies combat these financial problems?
We’ll review the basics of cash flow forecasting, then explain some of the most common reasons business struggle with their forecasts. Finally, we’ll give actionable tips to help your company get back on track and prepare for the future.
What is Cash Flow Forecasting, and Why is It Important?
Every business requires financial momentum to create growth– meaning that a reasonable prediction of future income and expenses is essential to survival. Your cash flow forecast informs spending limits, sales goals, and opportunities to gain additional capital through investors.
At its core, cash flow forecasting involves projecting future income and expenses, then subtracting the expenses from the income. Creating this forecast requires subtle understanding, reliable data on past performance, and realistic expectations.
How to Accurately Forecast Cash Flow
Creating a cash flow forecast follows simple principles, but the nuance guiding the principles can quickly decrease forecast accuracy.
- Determine the period.
Confine your forecast to a defined time frame, like quarters or years.
- Use past and current data to predict accounts receivable (AR).
Review CRM and investor data to determine a likely income amount for the given time frame.
- Use past and current data to predict accounts payable (AP).
Use expense reports, investments into target growth, and economic health signs to predict all outcomes for the given time frame.
- Integrate future AR and AP into a report.
At the most basic, your forecast should include your current balance, a line item for each future AR and future AP, and a final balance. After that, you can include more detail to explain the forecast.
- Check for accuracy.
Run all cash flow forecasts through “what if” scenarios to check both the viability of the current reporting methods and the probability of surviving negative market impacts.
5 Common Reasons Cash Flow Forecasts are Inaccurate
The adage “it takes money to make money” is at the core of cash flow problems for many organizations. As a result, many business owners feel pressure to produce impressive projections to increase company morale and impress investors. But mistakes and overconfidence can be deadly in cash flow forecasts.
Here are some of the most common ways businesses make mistakes with cash flow forecasts:
- Optimism Bias
Many businesses use their cash flow forecasts as a “best case scenario” report rather than properly accounting for realistic sales and expenses. Startups are particularly vulnerable to optimism bias because they have less data to use in projections and typically have a higher desire to prove their business.
Cash flow forecasts require a realistic sales number. It can include significant growth, but the projection should be based on solid market analysis, competitor results, and economic health.
Never “sugar coat” expenses– report what you are likely to really need, rather than reporting a bootstrap version of operations that cannot sustain business practices.
- Inaccurate Performance Data
It is impossible to create a reliable projection if your past data is unreliable. Quality data often depends on the software and systems you use, as human error is one of the greatest contributors to incorrect numbers.
Eliminate the risk of inaccurate data by employing the right financial software for your company operations. You will reduce data entry, incorrect formulas, and dependency on a single employee or team. You will also increase report quality, visibility, and decision-making ability.
- Failing to Run “What if” Simulations
Financial departments are not under pressure to read the future with 100% accuracy. Instead, forecasts present the most likely outcome under usual circumstances. However, stopping there leaves many companies vulnerable to significant obstacles.
Use multiple “what if” simulations to prepare your company for things like recessions, supply chain problems, and natural disasters. These reports can make the difference between being prepared to react to a disaster quickly and lagging far behind.
- Creating Static Forecasts
Many businesses create quality cash flow forecasts-- and then don’t update or revise them during the year. Unfortunately, treating a forecast as a static report often causes companies to misuse their cash flow and results in lower performance than necessary.
A flexible cash flow forecast requires a culture of embracing change and a reporting system that allows for adaptation. Quality financial software will enable easy forecast edits that trickle throughout multiple reports.
- Poor Communication
Communication is a challenge for many businesses, large and small. Businesses with poor company culture, unclear objectives, and scattered meetings are likely to misuse their available cash.
Instead, create clear policies on expenditure requests, approval, and tracking. Have regular meetings at multiple management levels to review progress. Ensure that employees feel supported and accountable for their expenses.
Use the Best Tools to Empower Your Financial Forecasting
While understanding correct principles and methodologies is essential to valuable forecasts and reports, using the best tools will vastly improve your success rates. Great financial analysis software will use robust reporting, real-time updates, quality and access controls, and clear reports for empowered decision-making.
Cofi empowers companies to produce precise cash flow forecasts easily and quickly from a centralized digital environment and with a single, streamlined workflow.
Request a demo today!