In times of uncertainty, the capability of an organization to navigate through significant instability can be the catalyst for long-term financial health. A cash-flow forecast model serves as an early warning sign to a company’s future business health by putting a forensic lens on cash balances under a variety of future circumstances.
Having a model that is dynamic, easily updated for changing conditions, and able to support iterative scenario analysis isn’t a luxury; it’s a necessity — as vital as a fire extinguisher in a furnace room. Moreover, a cash-flow forecast model should be simple enough to be operated and communicated across an organization’s entire leadership team.
Cash flow is the lifeblood of any business. If a company runs out of cash and cannot secure additional financing, it becomes insolvent. So, the need to view accurate forecasted cash positions always is critical. This is particularly important in times of market disruption, where unprecedented events, such as a global health pandemic, changing supplier/customer landscapes, or employment volatility, can lead to business failure if not properly planned. In particular, cash-flow forecasting can provide the following insights:
Additionally, external stakeholders, including lenders, will require a cash flow forecast to gain visibility to potential risks.
Depending on the depth of the information needed, a cash-flow forecast can be viewed monthly, weekly, or even daily. Daily cash forecasts can be important for some businesses, particularly when a cash shortage is probable. There are two optimal ways to forecast cash flow:
Long-term forecasting allows for future strategic planning but is susceptible to greater variability in outer time periods. Short-term forecasting provides greater granularity and accuracy of upcoming cash positions. Struggling businesses should utilize short-term forecasting to ensure survival through a potential cash-flow crisis. Ideally, all organizations should engage in both short- and long-term forecasting.
An organization’s cash-flow forecast should be straightforward and uncomplicated for use across the leadership team, providing key insights quickly. There are many software tools that specialize in cash-flow modeling, but Excel can be used effectively as well. The process for determining a business’s projected cash flow should include the following steps:
A cash-flow forecast should be modeled with multiple “what-if” scenarios for planning. This allows an organization to see various results of their forecasted cash position based on potential unknowns. Creating a variety of models will allow a business to see its cash flow position under a range of different future circumstances. This allows an organization to quickly adapt processes and build contingency planning protocols as needed. Scenario planning should be simple enough to produce a quick view, particularly when timing of decisions is critical. With multiple, dynamic scenarios, management teams can monitor company results and adjust plans.
Because an effective cash flow forecast will cascade throughout an organization, operability and understanding of the model by non-finance professionals is key. Insights within the model need to be understood by all key leaders, and an effective forecast often requires input from a variety of non-finance individuals throughout the company. An intuitive cash flow forecast will help drive ownership, as well as accuracy, through incorporation of operational knowledge.
Cash forecasting provides a clearer picture of where the company is headed as well as visibility into where improvements or adjustments need to be made. Many organizations don’t have the financial strength to survive short-term crisis or business disruptions. Having a cash-flow forecasting model on hand is vital for evaluating a company’s liquidity over a specific timeframe. An organization’s understanding of its cash position in the short and long term can help it make better decisions and avoid facing the unfortunate position of insolvency in the event of unforeseen circumstances.