Considering that running out of cash is one of the main reasons for a business to fail, it’s no wonder that accurate cash flow forecasting is a top priority for businesses across the globe. That’s according to a recent survey by Deloitte. Even with that goal in mind, 72% of finance professionals still use manual processes to create cash flow forecasts. Not only is this method time consuming, it’s error-prone–pretty much the opposite of what those surveyed reported was of utmost importance to them.
No doubt about it, forecasting is tricky, especially if you’re relying on manual processes. Here’s just a sampling of the factors that make creating an accurate forecast a nearly impossible task.
Take the fact that all your customers don’t behave the same way and pair it with an uncertain economy, and you can end up with too many accounts past due.
Using Excel for cash flow forecasting leads to mistakes and inaccuracies because humans–no matter how good they are at their job–will make errors while entering data. Also tracking changes is not easy with spreadsheets, nor do they offer much flexibility when it comes to reporting.
It’s becoming more common that leadership asks for forecasts more frequently than in times past. This high turnaround time doesn’t give finance teams much time for detailed analysis.
When financial data is spread across various places–ERPs, banks, accounting systems and FP&A tools–it’s challenging to collect complete data sets. Accurate forecasting depends on data from customer profiles, historical payment patterns and sales which is difficult to gather manually.
Outstanding invoices, payment trends, disputes–you need granular visibility into all these to create an accurate forecast.
Because many business decisions are made from your cash flow forecast, it’s critical that the forecast is as accurate as possible. To improve your cash flow forecasting, you need to overcome the above obstacles and adopt practices that lead to precision.
While there’s no one-size-fits-all answer for every business’s cash flow forecasting issues (or is there?), streamlining your workflows and standardizing your processes is a good place to start. The particulars of your business and your goals will determine what your cash flow needs are and that impacts your forecasting. For example, a business that sells outdoor living items and makes most of its sales during one quarter of the year has different forecasting needs than a business with a steady revenue over 12 months.
Making decisions from an inaccurate forecast can have far-reaching negative impacts. Say you are expecting a situation that requires you to have a large amount of cash, so you take out a loan. If that situation doesn’t materialize, you’ve gone into debt unnecessarily. Or maybe you set the cash aside and left it idle for too long, missing out on an investment opportunity. You can circumvent a liquidity crisis by making sure that management understands the importance of accurate cash flow forecasting.
In order to improve your cash forecasting accuracy you need to focus on changes that will increase the precision of your processes. Let’s take a look at some tips that are easy to implement.
It sounds too basic, but like with most business processes, clear communication helps you create a more accurate forecast. This includes everything from directives, workflow procedures and policies to the data and other inputs from various functions.
While both cash flow and revenue are indicators that you use in evaluating the financial health of your company, they are not interchangeable. Revenue shows how effective your sales and marketing efforts are. It measures the inflow of money through only one type of transaction.
Cash flow measures the cash that comes in through sales and other sources too. Unlike revenue, which will always be a positive number or value, cash flow can--unfortunately–be a negative number.
Cash flow indicates how well your money is managed. Obviously, revenue is important. But cash flow is the lifeblood of your business, providing a means for you to remain functional. You have to have enough cash on hand to meet your short-term obligations.
Again, this concept is basic. Your forecast needs to be a granular look at your cash position as it relates to both inflows and outflows. The first step is identifying how much money will be coming in over a specified period of time and the sources. Keep in mind this is not about the capacity of your business to make products or deliver services. It’s about what payments you expect to collect for your goods or services.
Analyze your historical sales data, but also take into consideration macroeconomic variables like consumer confidence levels. Of course, your sales will fluctuate so the communication lines discussed previously will provide a means for you to access insights and business drivers that could affect your numbers.
Verify that terms or relationships with your vendors are still the same. There may be changes that could affect how fast you’re paid or the amount. Looking for patterns in remittances can help you make more accurate forecasts.
Another Inflow category to take into account is product. New product releases will affect sales. On the other hand, a product recall will impact your forecast differently.
When forecasting your outflows, remember to include fixed as well as variable costs. Although overhead expenses such as salaries, rent and utilities may go up when you experience high volumes of business, you most likely can predict them with a level of accuracy.
As your production and/or sales increase, so will your variable expenses like cost of goods sold, seasonal inventory, quarterly taxes and extra pay periods. An accurate forecast depends on the timing of those payments. For instance, if your cost of goods is 50% and your sales goal for the first quarter is $100,000, you would need $50,000 worth of goods to meet your sales. It’s likely that you won’t need all that cash upfront. Labor costs need to be paid for immediately, but you can get materials on credit with favorable terms.
Other variable expenses include one-time expenses such as employee training, equipment and annual bonuses. If you’re unsure about an expense, go ahead and account for it in your cash flow forecast to be on the safe side.
It can be of value to create a few different scenarios. This helps you visualize how certain potential events or conditions could impact your business and how you would need to adapt if the situation occurs.
Accurate forecasts are the goal, but it’s important to remember that they are, after all, projections. Things will or won’t happen as you predicted and that means your forecast will be off. After you publish your forecast, you’ll need to keep monitoring it in real time. This allows you to pinpoint opportunities for improvement.
It’s rare that a forecast is perfect, so accept that fact and then decide how much variance you can accept. Make that your goal.
We saved the best tip for last. Adding AI-driven automation software to your accounts receivable is one of the easiest and fastest ways to see significant results. What happens if you experience a short-term cash flow crisis? Most businesses don’t have the financial fortitude to make it through that situation. But with accurate forecasts in hand you can make adjustments as needed.
The benefits of replacing your manual cash forecasting process with one driven by advanced technology are many:
Data capture: No more gathering all your financial data from multiple disconnected sources. The software automatically captures financial information from banks, digital spreadsheets and ERPs.
This streamlines the process while reducing errors and omissions.
Automated workflows: Replace time-consuming, mundane manual tasks.
This efficiency saves not only time and money, but frees your AR team to work on projects that contribute to the growth of your business.
Accurate predictions: AI algorithms can learn from historical data, customer profiles and more data points to predict payments.
AI/ML greatly enhances the accuracy of cash flow forecasts.
Real-time insights: The software provides you with real-time insights into your cash positions.
This visibility allows you to quickly take action for more effective management of your cash.
Cash flow forecasting is too critical to the financial health of your business to continue using outdated manual processes that are labor-intensive and prone to error. Adding AI-powered automation streamlines AR processes, improves the accuracy of cash flow forecasts, provides insights for better decision making and increases cash flow.
Payference is an all-in-one cash management tool that leverages AI/ML to improve cash flow forecasting. See how it works with a quick demo.