Measuring Forecast Accuracy: Tracking KPIs | Payference
We can thank modern business management guru Peter Drucker for coming up with the idea of KPIs and...
By: Payference on Apr 5, 2023 1:59:28 PM
One of the most common reasons for a business’s failure is inaccurate cash flow forecasting. So it’s no wonder that how to improve cash forecasting and prediction accuracy is a hot topic for companies, especially startups and mid-market businesses that usually don’t have as many resources as enterprise level organizations.
Forecasting varies by industry and individual goals. And as many of those struggling businesses have learned firsthand, it is difficult to consistently produce forecasts with a level of accuracy that makes them truly useful. Inaccurate cash flow forecasts are caused by a combination of several factors: using data that’s incomplete or not up-to-date, human error and a lack of efficient tools. When critical business decisions need to be made, it’s vital that they are based on accurate projections. For example, without accurate information, a business could borrow more money than is necessary and then end up having too much in idle funds.
In this article we’ll review the basics of how to improve cash flow forecasting and predictions and introduce some best practices to improve this all-important aspect of managing your company’s finances.
Cash flow forecasting is simply a process to help a business manage its liquidity and get an idea about whether it will have enough cash on hand to pay its bills. It predicts a business’s cash inflows and outflows over a period of time in the future. All expected revenue and costs are taken into consideration to identify a cash position and make cash flow projections.
Having an accurate cash flow forecast helps you manage your finances better and empowers you to make smarter business decisions. There are at least three ways you’ll benefit from improving your cash flow forecasting:
You'll have clearly identified cash inflows and outflows.
The process of how to improve cash flow forecasting predictions requires that you develop a thorough and transparent examination of your cash inflows and outflows. This means you’ll have insight into what makes your business perform well and a more precise view of your overall finances.
2. You’ll be able to quickly adapt if you expect cash shortfalls.
Obviously, not having enough cash to meet your financial obligations is not where you want to be, but being surprised by a lack of funds is even worse. Being able to see potential cash shortfalls ahead of time gives you time to make adjustments to your budget and make contingency plans.
3. You’ll make data-driven decisions that lead to better financial planning.
Once in a blue moon, a business just gets lucky and enjoys success. For every other business, it takes planning for the future to bring about success. But making plans for growth when you don’t have accurate data is misguided. When you’re able to make cash forecasts you can rely on, you’re in a much better position to make investment and funding decisions.
What to include in a cash flow forecast depends somewhat on your specific business, but in general, you’ll want to include the following inputs:
To ensure the accuracy of your cash flow predictions, it’s important to track all the cash that’s coming into your business. Some businesses may only look at revenue, but there are other sources of incoming cash.
Again, just like with cash inflows, it’s critical to take into consideration every cash outflow—not just the common, more visible ones.
Basically, there are two methods of cash flow forecasting: direct and indirect. Each has its own merits, but your specific needs will determine which one you decide to use.
Surprisingly, the more straightforward method (and the one that’s easier to calculate) of how to improve cash flow forecasting is actually the less common method used. This method is aptly named as the formula used for forecasting is, well, direct: Cash Flow = Inflows – Outflows. But because it’s time-consuming and cumbersome to collect all the data needed for this forecasting method, many businesses forego it, especially for those that use accrual -basis accounting over cash-basis.
For this method of cash forecasting, you start with your net income and then consider items that affect your profit but not your cash flow. Transactions are recorded before funds are actually received in accrual-basis accounting, so you must adjust your AR and AP to reflect cash flow. And money that’s been earmarked for taxes, but not yet paid, has to be added back in.
Naturally you want the most useful—most accurate--results from your cash flow forecast. Regardless of which of the two forecasting methods you choose, follow these three best practices to improve your cash flow forecasting accuracy.
Being able to accurately forecast cash inflows and outflows is dependent upon you also having an accurate financial plan for the same time period. You should have a plan and a forecast for the short-term and medium-term that are aligned.
Once you decide to get serious with how to improve your cash flow forecasting, stick with it. Inconsistency in reporting gives you unreliable information. You want cash flow forecasting to be business as usual.
Even the most meticulous financial team member will make mistakes. There’s just so much data to input and often it’s hidden in disparate sources. Consider automation software that will streamline your workflows, reduce human error and give you real-time cash positions for more accurate cash flow predictions.
Payference is an all-in-one cash management platform that uses machine learning and artificial intelligence to enhance your cash forecasting accuracy. With Payference, all your financial data will be in one place where it’s easily accessible and in real time. In addition, Payference provides scenario creation along with our automated cash flow forecasting process which gives business owners and finance teams pivotal insights at their fingertips.
If you’d like to discover more about improving your cash forecasting, reducing DSO while accelerating collections, set up a demo today.
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