Financial forecasting or cash flow management is a key aspect of financial management of a business, planning its future cash requirements to avoid a crisis of liquidity.
Cash flow forecasting is important because if a business runs out of cash and is not able to obtain new finance, it will become insolvent. Cash flow is the life-blood of all businesses—particularly start-ups and small enterprises.
As a result, it is essential that management forecast (predict) what is going to happen to cash flow to make sure the business has enough to survive. How often management should forecast cash flow is dependent on the financial security of the business. If the business is struggling, or is keeping a watchful eye on its finances, the business owner should be forecasting and revising his or her cash flow on a daily basis.
However, if the finances of the business are more stable and ‘safe’, then forecasting and revising 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 in advance—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 business; 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 are paying their debts. Note—this is not really a problem for businesses (like retailers) that take most of their sales in cash/credit cards at the point of sale.
- As an important discipline of financial planning—the cash flow forecast is an important management process, similar to preparing business budgets.
- External stakeholders such as banks may require a regular forecast. Certainly, if the business has a bank loan, the bank will want to look at the cash flow forecast at regular intervals.