Today, U.S. businesses continue to deal with an uncomfortable amount of uncertainty. Interest rates are on the rise, and the pandemic continues to linger, affecting demand and liquidity. Labor shortages also plague many employers.

While you generally can’t control these factors, you can take steps to mitigate the potentially negative consequences and, in turn, boost your short- and long-term prospects for success. One such critical step is cash flow forecasting.

Role of Forecasting

The importance of your financial statements is indisputable, but you need go further to ensure you can sustain day-to-day operations. After all, reporting healthy profits is no guarantee that you’ll actually have cash on hand to pay your bills. That’s why you need accurate forecasting to predict your expected cash inflows and outflows.

Forecasting empowers you to ferret out impending cash shortages and surpluses and plan accordingly. If shortages loom, advance warning gives you time to take measures to avoid problems meeting your debt and other payment obligations. In the case of projected surpluses, you may want to apply the extra funds to support strategies for future growth.

Scenario planning, a type of forecasting, can help you game out different circumstances and make more-informed strategic decisions, accounting for potential micro- and macro-economic conditions. For example, scenario planning could help you evaluate how an interest rate hike might impact the expected cash flows from an equipment or real estate purchase.

Forecasting also improves your agility. You’ll be better positioned to take advantage of unexpected opportunities or protect against sudden and unforeseen adverse developments.

Finally, cash flow forecasting provides reassurance to stakeholders. Potential investors and lenders, for example, like to see evidence that a business is prepared to withstand stagnation or downturns.

Keys to Effective Forecasting

Not all forecasts are created equal. Your choices will affect how useful your forecasts are for your business.

Forecasting on an annual basis generally is insufficient, even in the best of times. You’re better off preparing quarterly or, preferably, monthly forecasts. If new data unexpectedly emerges, you may decide to spontaneously update a static forecast to better-reflect current market conditions. In fact, some business favor rolling 13-week forecasts. Increasing the frequency increases accuracy, as you can more readily account for rapidly changing variables.

Obviously, it’s more challenging to predict inflows than outflows. To better forecast revenue, consider such metrics as average monthly collections, days sales outstanding and collections as a percentage of receivables.

Granularity also is valuable. You might, for example, examine receivables collection and inventory turn at the levels of business units, product lines or individual customers. You should similarly scrutinize your outgoing payments to vendors — how often do you pay, and is that schedule the most beneficial for your cash flow? Getting granular will make it easier to identify trends that affect working capital accounts.

Reach outside of the accounting and finance departments for inputs, too. Cash flow forecasting is best when it’s an interdisciplinary exercise. The sales department, for example, might know about potential revenue disruptions on the horizon, while accounting is completely unaware. HR could anticipate higher compensation costs as a result of a planned recruitment drive.

Review and Revise

Consistent cash flow forecasting is only part of the equation — you also need to regularly review your forecasts for accuracy. Check the predicted figures against your actual numbers, determine the reason for any significant discrepancies and adjust accordingly going forward. The greater financial certainty that results will help your business better weather shifting conditions.

Contact our CFO Services team to help assess your current forecasting techniques. We can be a valuable resource for fresh, market-based perspectives during these uncertain times.