Cash flow forecasting is the process of estimating the business’s future cash levels over a specific period of time. This financial management tool helps businesses anticipate cash shortages or surpluses, allowing them to make informed operational and strategic decisions.
By accurately predicting future cash levels, companies can ensure they have enough liquidity to meet their financial obligations, invest in growth opportunities, and avoid unnecessary borrowing costs.
Cash flow forecasting is a crucial financial tool that helps businesses predict their future financial position. By anticipating the inflow and outflow of cash, companies can better understand their future cash positions, enabling them to make informed strategic decisions. This forecasting ensures that funds are available to cover obligations as they arise, thereby maintaining liquidity and avoiding potential cash shortages.
Essentially, cash flow forecasting provides a roadmap for financial planning, enhancing a company's ability to navigate future financial landscapes with confidence.
Cash Flow Forecasting vs Budgeting
A cash flow forecast predicts when income and expense charges come in and out of the bank account. A budget helps plan resources and capital for a project or business objective.
Budgeting provides a detailed financial roadmap, outlining projected revenues, costs, and resources. In contrast, cash flow forecasting zeroes in on when exactly these financial movements will occur.
Though different in focus, cash flow forecasting and budgeting are complementary. Budgets set financial targets and allocation plans that cash flow forecasts monitor in real-time. By integrating both, businesses ensure they are not only planning their finances meticulously but also dynamically adapting to cash movements. This combination helps balance long-term goals with current financial health, for accurate financial decision-making and skilled strategic planning.
Real-World Example of a Cash Flow Forecast
ABC Inc. is a small hardware store. ABC Inc. wants to estimate the cash coming in and going out for September to ensure they can cover all their expenses and plan for any unexpected costs.
They’ll start by listing their expected cash inflows. This includes:
1. Sales revenue: $25,000
2. Customer payments on outstanding invoices: $7,000
3. Investment income: $1,000
The total of the above figures gives ABC Inc. a total projected inflow of $33,000 for September.
Next, they list their expected cash outflows, such as:
1. Supplier payments: $10,000
2. Employee salaries: $8,000
3. Utility bills: $1,500
4. Rent: $3,000
Miscellaneous expenses: $1,000
The total projected outflow amounts to $23,500.
By comparing the inflows and outflows, ABC Inc. calculates a net cash flow of $9,500 for September, meaning the business will have a surplus, leaving room for investment or savings for unforeseen expenses.
ABC Inc. will continuously update their forecast as data comes in, allowing them to adjust their spending and prediction models to maintain healthy liquidity. This proactive approach helps them to smoothly navigate through financial uncertainties.
How to Create a Cash Flow Forecast
Creating a cash flow forecast involves several key steps:
1. Determine your forecasting objective
2. Choose forecasting period (short term e.g. 13 weeks or long term e.g. 12 months forecast)
3. Choose forecasting method (direct or indirect)
4. Source your financial data
See this article for a more detailed guide on how to build a cash flow forecast
Why is Cash Flow Forecasting Important
Cash flow forecasting offers several key benefits that drive business success. Here’s a list of reasons why this tool is important.
Improved financial planning
By accurately predicting future cash inflows and outflows, you can ensure that your business remains solvent and can cover its obligations. Financial planning enables precise budgeting and resource allocation to areas that promise the highest returns.
Risk management
With a clear picture of your cash flow, you can identify potential shortfalls well in advance. This proactive approach allows you to address issues before they become critical, whether by securing additional funding or strategically adjusting expenditures.
Better decision making
Equipped with detailed financial projections, you can make informed decisions such as when to expand, invest in new projects, or reduce costs. This not only supports growth but enhances your ability to respond quickly to changing market conditions.
Cash flow forecasting is a crucial tool that allows businesses to proactively manage their financial health. Whether it's allocating funds for new investments, paying down debt, or simply ensuring that all bills are paid on time, cash flow forecasting provides the clarity needed to make informed financial decisions.
Difference Between Cash Management, Cash Forecasting & Liquidity management
While interrelated, each financial tool has a distinct role in managing a company's cash and overall financial health. Let's break down the differences:
Cash management: This refers to the broad process of collecting, managing, and investing a company's cash and cash equivalents. The primary goal of cash management is to optimize liquidity, ensuring that the company has enough funds to meet its short-term obligations, while maximizing returns on any idle funds. Put simply,, cash management is about making the most efficient use of cash on hand.
Cash flow forecasting: Unlike cash management, which focuses on current cash, cash flow forecasting is future-based. It predicts the timing and amounts of future cash inflows and outflows based on historical data, market conditions, and business activities. Accurate cash flow forecasting is crucial for strategic planning and helps businesses anticipate funding needs, avoid liquidity shortfalls, and make informed decisions about investments and expenditures.
Liquidity management: This is the practice of ensuring a company can meet its short-term obligations and continue operations without financial stress. It encompasses both cash management and cash flow forecasting, but also includes managing other liquid assets that can quickly convert to cash. Effective liquidity management ensures that a business maintains sufficient cash reserves or access to capital to handle unexpected expenses or opportunities.
By understanding and utilizing these three financial strategies, businesses can maintain a robust financial standing, ensuring they are well-prepared for both current needs and future challenges.
In a recent conversation between Adi Barak, VP of Product at Panax, and Joel Jeselsohn, VP of Finance at Tangoe, the two finance experts dove deep into the challenges and opportunities facing finance teams around cash forecasting, especially for mid-sized global companies. They touched on topics such as the impact of inflation, the importance of cash forecasting, and the role of automation and AI in financial processes. Here are the main takeaways from their discussion.
The Case for Automation in Cash Forecasting
Both Joel and Adi stressed the advantages of automation in cash forecasting, pointing out that it minimizes errors, boosts efficiency, and allows teams to focus on higher-value tasks. Manual processes, such as data collection and tagging transactions, are time-consuming and prone to error. By automating these processes, finance teams can free up time for data analysis and decision-making, ultimately creating more value for their organizations.
Joel shared his own experience with automating Tangoe’s forecast, revealing that while their manual processes were “good enough,” automation took their forecasting to the next level. The shift allowed Tangoe to scale its operations without increasing headcount, improved team morale, and enabled the company to extend its forecast horizon from 13 weeks to as far as 12 months.
By automating cash forecasting processes, finance teams can free up time for data analysis and decision-making, ultimately creating more value for their organizations
Managing the Risks of Automation
Despite the clear benefits, Joel and Adi acknowledged that automation comes with risks, such as the potential for low adoption and integration issues with existing systems. They recommended ensuring that finance teams remain hands-on, focusing on analyzing data rather than becoming too reliant on automation tools.
Another challenge is that forecasts are only as good as the data that goes into them. Automation tools should be carefully monitored to ensure that they accurately reflect the financial health of the organization, and finance teams must remain vigilant in identifying any potential errors or discrepancies.
AI’s Role in Financial Forecasting: Hype or Reality?
Joel and Adi both agreed that AI is not just hype; it holds real promise for improving financial processes, especially in forecasting. AI excels at analyzing historical data and generating projections much faster than human analysts. However, they pointed out that AI is not a replacement for human oversight, particularly when it comes to decision-making in unique or unpredictable situations.
For instance, AI might not be able to account for significant events like acquisitions unless explicitly programmed to do so. Where AI can add value is in running multiple scenarios simultaneously or predicting customer payment behavior based on past trends, providing finance teams with more accurate forecasts.
Measuring Forecast Accuracy and Reporting
When it comes to measuring the accuracy of forecasts, Joel stressed the importance of comparing actual results to the forecasts made weeks or months earlier. This approach allows teams to fine-tune their models, identify trends, and adjust forecasts as business conditions evolve. Accurate forecasting depends on regular evaluations and the ability to quickly pivot when unforeseen circumstances arise.
AI and Automation are the future of finance, but only when managed by the finance team, and not replacing the finance team.
As automation and AI become more integrated into financial processes, the role of finance teams is evolving. Rather than focusing on manual data entry and basic tasks, finance professionals are now empowered to focus on strategic analysis and decision-making. Both Adi and Joel made it clear that embracing these technologies is no longer optional—it’s essential for staying competitive in today’s fast-paced business environment.
Automation and AI offer finance teams the tools they need to navigate an increasingly complex financial landscape, but human oversight and expertise remain critical. As companies continue to adapt to this new reality, those that successfully integrate these technologies into their operations will be better positioned to thrive in a post-pandemic world.
Watch the full recording of the webinar here, or click here to download our e-book, for a deep dive into AI and Automation in Cash Forecasting.
Finance teams are required to forecast cash for multiple reasons:
- Staying ahead of upcoming inflows and outflows and preventing a potential short fall of cash
- Identifying opportunities of excess cash that can be invested and gain interest
- Contingencies/requirements from investors or banks
But despite the fact that forecasting is a critical tool in financial planning, many organizations struggle to get it right.
Common challenges include data inaccuracies, time-consuming manual processes, and the reliance on outdated methods. These issues can lead to unreliable forecasts, making it difficult for businesses to plan for the future, manage cash flow, and mitigate risks effectively.
Panax's forecast feature is designed to address these challenges head-on, providing businesses with a powerful tool to navigate their financial future with confidence.
Cash forecasting with the Panax platform
Panax’s forecast capability allows our customer to build a monthly forecast. The goal is to allow our customers to foresee their expected inflows and outflows and the expected balance, so they can maintain control and make data-driven decisions. The forecast can either be built at a company level or per entity and then aggregated to a company level.
Why forecast with Panax?
- Accuracy - Panax connects to all your banking data, providing an easy and automated way to base your forecast on historical data and future ERP data. This allows you to easily and more accurately plan future inflows and outflows.
- Automation - We generate the forecast automatically each month by rolling your forecast based on your input assumptions and updated actuals.
- Bottom up and customized - We allow you to create forecast methods based on your knowledge of the cash flow. Each category can be configured per your understanding and adjusted to your needs.
How Panax forecasting works
Initial setup
First, define a forecast method. This will determine how the forecast is populated. You can choose between a few different methods:
1. ERP-based - If you have an ERP connected to Panax, you can pull your expected invoices from the ERP and place the total amount as a forecast for the time period they apply to. You can then layer on additional forecast methods for the following months, from additional sources of data.
2. Recurring amount - Input an amount that repeats monthly. You can also add a formula to increase/decrease the amount month-over-month.
For example, if your office and rent expenses are $120,000 you can input that amount. It will be populated throughout each month of the forecast for that category.
3. Based on historical data - By bringing in all your actuals, you can rely on the historical behavior of a certain category to build a forecast. This will be based on the average over a certain period, the growth rate over a certain period, or on your annual growth rate.
For example, if your sales are seasonal, you can build the forecast for your collectionsit to be based on the same month last year’s month sales + add a growth rate.
4. Based on data from another category - You can also rely on amounts from other categories, which means your forecast can be calculated as a % of that category.
For example, if your shipping expenses are 3% of last month’s collection, you can add that method point to last month’s collection. Panax will populate the forecast for shipping, based on the forecast for collection.
5. Manual input - You can also manually define an expected amount per month and use that as you forecast.
For example, if your marketing spend is based on a plan you receive from the marketing team, you can just input the spend manually per month.
Actuals vs. forecast
When the month ends, we will automatically roll the forecast and create a new version that is based on the updated actuals. You will see an end-of-month summary that compares this current month actuals vs. forecast:
Based on this summary you can adjust and optimize your forecast for the following month.
Reporting and analytics
Use the variance report to review what was forecasted for a specific month in a previous months version of the forecast vs. what you are forecasting now. For example, if in May your forecast showed the Closing balance in July to be at a certain amount and then in June the forecast was updated and now the closing balance for July shows a lower amount, you can drill down into the inflows and outflows to better understand what in the actuals / forecast was changed that caused that difference.
By leveraging the variance report, you can:
- Identify Discrepancies: Quickly pinpoint where and why discrepancies between forecasts occur, whether due to changes in revenue, expenses, or other financial factors.
- Improve Accuracy: Use insights from the variance analysis to adjust your future forecasts, making them more accurate and reflective of real-world changes.
- Enhance Decision-making: Gain a deeper understanding of your cash performance, allowing for more informed strategic decisions and proactive liquidity management.
- Increase Accountability: Track and explain variances to stakeholders, ensuring transparency and accountability in your forecasting process.
Learn more about Panax forecasting and how automation can help you do your job better.