Armanino Blog

Cash Is King: How to Optimize Your Cash Position With a Cash Flow Forecast

by Eric Thomas
August 30, 2017

An entrepreneur I know says that someone truly becomes a business owner only after they've spent a sleepless night worrying about making payroll. We disagree. You and your organization can avoid many stressful situations, and make better decisions, by planning with a cash flow forecast.

What is it?

A cash flow forecast is a tool to predict your cash position in coming weeks and monthsۥsomething that's useful for all types of organizations. You pick a set period, like the coming month or quarter, then subtract your expected expenses from expected receipts to see if you're building cash, spending it or staying at the same level.

A simple way to calculate this is: Receipts less payables less payroll less any unusual items (special events, capital expenses, etc.) equals the change in your cash position.

Why do you need a forecast?

You can't manage what you don't measure. Once you start paying attention to your cash, you're likely to make better decisions about how to use it. Organizations that are low on cash need a forecast because they don't have the resources to manage a sudden negative stretch. If you have a strong cash position, forecasting is still a useful tool for managing your finances.

A cash flow forecast helps you plan operations. For example, if you're going through a great stretch of sales, it's easy to overspend thinking the good times will continue. A forecast could warn you to be conservative because things are about to tighten up. It also helps you predict problems earlier, so you can be more proactive. If you anticipate that you're going to run low on funds, for instance, you can apply for a line of credit before the crunch hits.

If your forecast shows you're building too much cash, you can start thinking of more productive uses for the money, such as hiring, opening a new office, or moving it into your investment account. Remember―there's an opportunity cost for holding too much money in the bank, where it earns practically nothing.

What should you consider when developing your forecast?

Look at these four main factors:

  1. Timeframe - Are you looking out four weeks to predict your cash flow? Eight weeks? An entire quarter? If your activity is volatile, keep the timeframe shorter. If your results are consistent, you can predict further out.
  2. Frequency - You also need to decide how often to update your forecast. Weekly? Monthly? Quarterly? The frequency depends on the ebb and flow of your cash position. If money is tight, you need current information, so update weekly with a four-week timeframe. If you have plenty of cash, you can manage with less frequent updates.
  3. Audience - Who's going to review your forecast? Is the audience is internal, you probably want a working file that is weekly. If the forecast is for your board or management, it may be monthly or quarterly.
  4. Level of detail - If the forecast is for your board, you want it to be high level. If it's for your own internal use as a working tool, you'll want more detail.

What's the optimum amount of cash to hold?

There's no one answer, as it depends on your organization's goals and operations. In general, mature organizations with more predictable business cycles can hold less cash, and newer organizations should hold more.

You should also consider the frequency and predictability of your cash receipts. A tech firm with a subscription business model typically can hold less cash because money comes in every week, for example, while an ad agency that constantly needs to find new projects should have more cash in case they hit a slow stretch.

Upcoming activities are another factor. Any there any capital expenditures on the horizon that you need to save for? What about fundraising events, like a new donation campaign? In that case, you could spend more now knowing you'll be raising money soon.

Analyzing your forecast

Once you have your cash flow forecast, compare it to your past results. If your prediction is similar to what happened in the past, that's a good sign. Then later on, see how close your forecast was to your actual results, so you can adjust your next estimates as needed.

As you review your forecast, look for any cash flow trends. Are there certain weeks or months during each quarter when expenses and receipts are higher than usual? For example, you may notice that most of your expenses are at the start of the quarter, but your customers typically pay a month later, so you need to budget carefully until receipts start coming in.

Some forecasting best practices

Always use your book numbers for forecasting, not bank numbers. Your bank numbers can catch you off guard when you have outstanding checks. You should also consider payment terms for clients when forecasting cash receipts. If you give clients 90 days to pay, don't forecast that invoices will be paid in 30 days.

Talk with your sales and operations teams to understand what's coming up and what could be changing. Is there a new marketing campaign that could increase incoming receipts? Has the sales team landed a new client, and if so, when are they getting paid?

Finally, consider what's changed since your last budget. Given that budgets are obsolete on day one, what do you know now compared to when you first put together your budget, and how will this impact cash flow?

Cash really is king for every organization, so don't leave your planning up to chance. With a cash flow forecast, you have a simple and effective way to foresee problems and opportunities, and make better financial decisions.

Find more helpful insights from Armanino's Outsourced Finance & Accounting team.

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Eric Thomas - Partner, Consulting - San Ramon CA
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