Cash Flow Forecasting: Pros & Cons You Should Be Aware Of

Cash flow forecasting allows your business to plan for future cash needs by anticipating future cash inflows and outflows within a specific timeframe. Although this can enable you to be prepared and adjust to changing circumstances, cash flow forecasting still has drawbacks.

Below, we dive into the pros and potential pitfalls of cash flow forecasting to help you optimize your use of the process.

6 Key Pros of Cash Flow Forecasting

1. Equips Businesses With Predictability & Foresight

As you create cash flow forecasting calculations, we recommend that you look at individual streams of revenue as well as liabilities from expenses. This information allows you to anticipate when there will be a cash surplus and when funding will be tight. You can then allocate that surplus when needed. You can also accurately predict other things, including market conditions or political influences, that might impact your cash flow and overall business growth.

2. Mitigates Cash Shortages & Enables Anticipation of Bottlenecks

Cash flow forecasts can reveal potential cash flow shortages, helping you avoid insolvency or at least lessen its impact. For example, management could postpone investments, liquidate assets, lower cash withdrawals, or pay suppliers with credit to minimize cash flow shortages.

3. Enables More Informed Future Planning

Cash flow prediction helps you decide if a significant purchase can be made without jeopardizing the company's financial health. It’s a way to see if your organization can handle introducing new products or when is the best time to retire executives.

This shows top management when and how the company can achieve stability.

» Discover the benefits and difficulties of conducting a revenue analysis when planning for the future

4. Helps Determine Whether or Not Spending is on Target

No matter how big or small, we know that every business has monetary targets it aims to hit. By analyzing your company's cash flow prediction, you'll learn if and when your goals are within reach.

Moreover, you get to look closely at your budgeting and individual line items, analyze any patterns, and create more accurate budgets in the future.

» Follow these tips to keep track of your business expenses

5. Simplifies Keeping Track of Overdue Payments

Small businesses often extend credit to customers, which we think can be a risky move. A cash flow forecast helps you keep tabs on outstanding payments and better prepare yourself for any expenses or liabilities that might come up.

It's also a way to manage any credit you offer customers who frequently miss payment deadlines.

6. Streamlines Management of Surplus Cash

It’s essential to know when a surplus will occur so that you can make sure the money is used in the most effective way possible. For example, use it for debt reduction or reinvestment into your business.

A few months of surplus implies you can afford to make long-term investments such as new products or services or implement new processes.

» Follow this beginner's guide to profit and loss statements to help manage cash flow

5 Fundamental Cons of Cash Flow Forecasting

1. Complicated to Account For Unforeseen Factors

We want to stress that cash flow forecasting is not an exact science. Many uncontrollable factors can affect the forecasted numbers: environmental changes, changes in political leaders, inflation, and emergency repairs.

2. Always Involves Some Degree of Probability

While doing calculations, you might assume that nothing unexpected will happen in the future—no promotions, no price increases or decreases, and so on. This is unrealistic and could spell bad news for your company if you use it as a basis for business decisions.

3. Provides a False Sense of Security

When you’re laying out your plan, you tend to create it with a positive outlook. But in reality, there’s a wide range of variables that impact the cash flow of your company. If you don’t have money set aside for unexpected occurrences, you're forced to make budget concessions elsewhere.

4. Manual Errors & Miscalculation May Result in Debt

There are several potential issues you can face if you manually compile your cash flow forecast in a program like Excel. Inaccurate computations result from a number of human errors, including sloppy data entry, imprecise formulas, and duplication. All of these can be very expensive mistakes.

5. Can Result in Ineffective & Uninformed Decision-Making

If your cash flow forecast is poorly crafted, you'll make ineffective and ill-informed decisions. For example, your company makes a large investment in cutting-edge production machinery in anticipation of future growth, only you're caught off guard later by an unanticipated change. If your revenue projections are too optimistic, you're in danger of overspending.

The wrong forecasts put your business at risk of bankruptcy or other financial crises.

» Analyze your net, gross and operating profit margins to make sure you stay on track

What's the Verdict on Cash Flow Forecasting?

While a cash flow forecast is an excellent way to predict the future financial health of your business, you should be aware that it’s not always accurate. Since cash flow forecasts don't consider many external factors, it's up to you to monitor and adequately respond to what's happening.

We recommend that you incorporate accountability in all areas and include periodic reviews of your projection to control your finances better.