Cash flow forecasting is a time-tested, essential process for startup founders to gain a detailed understanding of their company's overall financial health. It helps you more accurately predict profits and losses while improving your investor reporting and communication. Adequate funding remains a key challenge for many entrepreneurs. With this in mind, it's especially important for you to manage your startup's cash flow as effectively as possible.
In fact, 82% of business failures stem from poor cash flow management, highlighting the critical importance of accurate financial forecasting for startups. If you want to ensure your startup has sufficient funds for growth, you'll need an accurate and proactive cash flow forecast.
Strong cash flow forecasting positions you to prepare your company for the future and to make informed strategic finance decisions that minimize your financial risk while driving overall performance and growth. Below, let's dive into some of the most common cash flow issues you may face and discuss how to avoid them.
What is a Cash Flow Forecast for a Startup?
A cash flow forecast is a projection of how much cash is expected to flow into and out of a startup over a set period. It helps founders anticipate future revenue, manage operating expenses, and ensure sufficient liquidity for growth.
A cash flow forecast is a way to predict your company's future financial position based on two primary elements: accounts receivable and accounts payable (cash inflows and outflows). It's a vital method for ensuring you stay on top of debt obligations, pay your bills, and maintain enough cash to support operations and growth. If you have a positive cash flow, you have more money coming in than you're paying out, whereas a negative cash flow indicates outflows exceed inflows.
There's a direct link between how far into the future you want your forecast to go and its accuracy. For instance, it's usually much easier to understand your cash flow over the next month because you'll likely have current client orders, near-term payments to collect, and known accounts payable. By comparison, predicting your financial position a year from now is more challenging because many variables—like market movements, business performance, or funding access—could influence the outcome.
Direct vs. Indirect Cash Flow Forecasting
In a direct forecast, you project definitive cash inflows (e.g., sales receipts) and outflows (e.g., rent, salaries) on a line-by-line basis. In contrast, an indirect forecast starts with net income and adjusts for non-cash items like depreciation, plus changes in working capital.
The Benefits of Cash Flow Forecasting: Why is It Important?
Periodically predicting your startup's financial health for a given timeframe helps you handle cash management in many crucial ways.
It gives you insight into your company's future health.
It highlights unexpected developments, such as becoming cash-negative.
You can identify and plan for cash flow shortfalls.
A cash flow forecast helps you avoid overlooking important cash outflows.
You'll get a better idea of current and future capital needs.
Predicting the future helps you hedge against downside risk.
It provides insights for your investment and financing decisions.
A good forecast helps show investors a detailed picture of their investment.
If you forgo cash flow forecasting or treat it as an afterthought, you'll put your company at a disadvantage. Without understanding your predicted financial health, you adopt a passive position. When you don't have insight into future cash flow, it's harder to plan strategically and properly allocate capital.
You might overestimate your financial health and suddenly find yourself in debt. Failure to produce optimal cash flow forecasts can also damage investor confidence.
How to Forecast Your Cash Flow in 5 Steps
Step 1: Select Your Forecast Period
Decide on a timeframe for your cash flow forecast. It might be monthly, quarterly, or as long as six or 12 months.
Step 2: Identify All Inflows
Identify your sources of cash inflows. These typically include sales revenue, but they can also come from tax rebates, sales of equipment, interest, or government grants. Consider any incoming payments you're due to receive, such as client payments on specific dates, standing orders, or subscription fees.
Step 3: Identify All Outflows
Next, list all your cash outflows. These generally include employee salaries, supplier payments, utility bills like electricity, rent, hardware and software purchases, and other expenses. Make sure you have a thorough understanding of every payment due during the forecast period.
Step 4: Calculate Your Net Cash Flow
Start with your opening balance — the amount of money in your bank account. Then, sum your total inflows and subtract your total outflows. The result is your projected net cash flow. If it's positive, you have a surplus; if it's negative, you may need to secure additional funding or reduce expenses.
Step 5: Validate and Adjust Regularly
At the end of each forecast period, compare your actual inflows and outflows to what you initially forecasted. Identify any discrepancies and adjust future forecasts accordingly. This regular review process helps refine your forecasting accuracy over time.
Quick Cash Flow Forecast Example
For instance, if you expect $10,000 from product sales in January and your expenses total $7,500, your projected net cash flow for January is $2,500. Repeating this monthly ensures you track seasonal fluctuations and spot potential shortfalls.
5 Common Cash Flow Forecasting Challenges
Accurate forecasting depends on getting several factors right. If you consistently review each forecast and compare it to actual outcomes, you'll improve over time. Below are the most common cash flow problems startups face when forecasting.
1. Optimism bias
The prevalent human trait of 'optimism bias' can cause you to overshoot sales predictions and underestimate the potential for negative financial developments. It's crucial to remain realistic about both inflows and outflows.
2. Inaccuracies from manual data entry
Relying on manual processes and traditional tools like spreadsheets raises the possibility of human error. Non-uniform methods among different employees can create inconsistencies, slowing cash management efficiency. A cash flow forecast can only be as good as the quality of its data.
3. Failing to update forecasts regularly
Market and business conditions often change unexpectedly. If you don't update your forecasts to reflect such changes, you increase financial risk. The longer your forecast period, the higher the need for amendments, given the likelihood of new variables.
4. Lack of communication among team members
High-quality data and free-flowing information are critical for precise forecasting. If your finance department isn't aligned or if interdepartmental communication is lacking, it becomes more difficult to maintain accuracy.
5. Eschewing scenario planning
Drafting multiple scenarios provides greater insight into your future financial positions. For instance, scenario planning might include three forecasts:
predicted,
worst realistic case scenario, and
best realistic case scenario.
Tips for Improving Cash flow Forecasting
You can implement several measures to build an efficient, effective cash flow forecasting process.
Understand why it is important
It's key for you and your department managers to fully grasp why accurate forecasts matter. When everyone understands the benefits, they're more likely to contribute reliable data and consistency to the forecasting process.
Define a forecast process
Your finance team should follow clear guidelines on when to begin each forecast, when to deliver it, and where to obtain the necessary data. The collaborative processes with other departments should also be well-defined. For instance, each department should submit its budgetary requirements on time. You should also have a technology stack in place to power the workflow and collaboration processes.
Define the data process
Data is the key business asset for any cash flow forecast. So it's crucial to optimize how you source, record, store, transfer, and analyze data.
Commit to variance analysis
After the fact, compare and contrast your forecast with the real outcomes. This helps you pinpoint where the forecast differed and offers insights into improving next time around.
Regularly update forecasts
Because market conditions shift, you should revise your forecast whenever significant new data emerges. For example, if a customer fails to pay or you secure additional capital, adjust your forecast to reflect the change.
Forecast right with Abacum
A well-structured cash flow forecast can mean the difference between merely surviving and truly thriving as a startup. Incorporating scenario analysis, being realistic with estimates, and regularly revisiting forecasts ensure you stay ahead of any cash crunch. If you're ready to build an accurate forecast that keeps your business resilient, explore how Abacum can help you every step of the way.
Abacum empowers you to produce precise cash flow forecasts quickly and easily, all from a centralized digital environment and a single, streamlined workflow. With Abacum, you can embed fast, collaborative processes across your company and manage data flows in an optimized way, all to support a best-of-breed cash flow forecast process. Moreover, Abacum is designed to make forecast updating and reporting simple and convenient.
If you're looking to streamline your startup's cash flow forecasting processes, request a consultation to see how Abacum can help.
