Comparing Cash Flow Forecasting and Budgeting
Cash flow forecasting helps identify trends in incoming and outgoing cash so that companies can prepare for future expenditures, avoid excessive debt, and meet payroll obligations. This process often involves using budgeting to determine how much money will be required over a given period of time. This type of forecast also takes into account other factors such as the cost to produce goods or services, expenses related to ongoing operations, interest payments on loans, capital repayments, tax instalments and other assets required to help grow a business.
Cash flow forecasting and budgeting are two important tools for any business. A budget is an amount that an organization intends to generate or spend on specific activities, or products during a period of time. These are usually built-in line with financial years and will be at least a 12-month outlook, with some extending 3-5 years. They are built as the targets for business performance and cascaded to relevant managers and directors to take ownership of their areas.
A cash flow will forecast the expected inflows and outflows within an organization over a given period of time. A cash flow is initially built using the budget, as it uses forecasted income and expenditure to predict when the cash will either be received or paid. There will be a long term cash flow in line with budgets, however for a business to keep detailed track a 12-week rolling forecast should be used to help businesses manage their cash over a shorter period and be updated regularly for day to day movements in trading.
It is often said that cash flow forecasting is one of the most important aspects of running a business but for a cash flow to work a business will need some form of a budget to know how trading will impact its cash position.
Forecasts can be used to identify when a company will need to invest money in more assets and anticipate any upcoming revenue shortfalls, allowing businesses to take proactive steps in order to ensure that they are able to meet their obligations, avoid being forced into bankruptcy, or take out debt unnecessarily
The benefits of cash flow forecasting
Cash flow forecasting is the process of predicting a company’s cash flows. It can be used to forecast any type of transaction that affects a company’s liquidity, such as sales, collections, debt payments and expenses.
Some of the benefits include:
– Improved decision making
– Better control over cash resources
– Optimized use of funds
Drawbacks of cash flow forecasting
Cash flow forecasting is a very useful tool in predicting the future of a company. however as it is a ‘forecast’ it only predicts what you expect to happen in the future, not what will actually happen, therefore having a short term cash flow is key, so you can keep actual trading updated to ensure day to day cash flow is monitored
Additionally, forecasting can be complex and time-consuming to build, therefore finding the time and skill set in house to rely on accuracy can be difficult to manage.
Cash flow forecasting and budgeting are two methods of planning that are used to help businesses better understand the future. One focuses on budgeting the trading of a business, whilst the other focuses on how that trading will be paid so that businesses can monitor their cash position over a period of time, ensuring they can continue to meet their payment obligations.