Financial forecasting or cash flow management is a crucial aspect of the financial management of a business, planning its future cash requirements to avoid a liquidity crisis.
Cash flow forecasting is important because if a business runs out of cash and cannot obtain new finance, it will become insolvent. Cash flow is the lifeblood of all companies, particularly start-ups and small enterprises. As a result, it is essential that management forecast (predict) what will happen to cash flow to ensure the business has enough to survive. How often management should forecast cash flow depends on the business’s financial security. If the company is struggling or is keeping a watchful eye on its finances, the business owner should be forecasting and revising its cash flow daily. However, if the business’s finances are more stable and ‘safe,’ then predicting and adjusting cash flow weekly or monthly is enough. Here are the key reasons why a cash flow forecast is so important:
- Identify potential shortfalls in cash balances and think of the cash flow forecast as an “early warning system.” This is, by far, the most important reason for a cash flow forecast.
- Make sure that the business can afford to pay suppliers and employees. Suppliers who don’t get paid will soon stop supplying the industry; it is even worse if employees are not paid on time.
- Spot problems with customer payments. Preparing the forecast encourages the business to look at how quickly customers pay their debts. Note this is not a problem for businesses (like retailers) that take most of their sales in cash/credit cards at the point of purchase.
- As an essential discipline of financial planning, the cash flow forecast is a necessary management process, similar to preparing business budgets.
- External stakeholders such as banks may require a regular forecast. Indeed, if the business has a bank loan, the bank will want to look at the cash flow forecast at regular intervals.