What Is Cash Flow Forecasting? How To Do It

Cash flow forecasting helps business owners understand how much money is flowing through their company, which can help them plan for growth.

Have you ever reviewed your business account to ensure that incoming payments align with your upcoming expenses? Or perhaps you've made a significant business investment, strategically spreading the cost over several financial periods to manage cash flow effectively.

If so, you’ve already participated in cash flow forecasting. 

In the accounting world, cash flow forecasting is a tool that allows companies to estimate net income over a given period of time. It helps business owners meet obligations, monitor expenses, and plan for growth. 

What is a cash flow forecast?

Cash flow forecasting is the process of estimating the amount of cash that will enter and leave a business over a given period.

Let’s say that an ecommerce business wants to run a 12-month cash flow forecast. If this business anticipates an inflow of $80,000 from online sales and an outflow of $30,000 for operational expenses over the next 12 months, it can forecast a net cash flow (or net income) of $50,000 for that period of time.

Direct vs. indirect cash flow forecasting

There are two different methods of cash flow forecasting: the direct method, which deals with known income and expenses, and the indirect method, which deals with projected income and expenses.

• Direct cash flow forecasting. Direct forecasting deals with known costs and this method is generally appropriate for short-term forecasting. A business might use direct cash flow forecasting at the beginning of a month, for example, to make sure that it will have enough working capital to pay end-of-month bills. 
• Indirect cash flow forecasting. This method makes long-term predictions. It involves using projected balance sheets (also known as pro forma balance sheets) and projected income statements. The indirect method also accounts for factors that affect profitability but don’t affect cash balance, such as depreciation on buildings and equipment. 

How to forecast cash flow

Cash flow forecasting follows a repeatable process. 

1. Prepare your cash flow statement
2. Estimate upcoming sales
3. Predict business expenses
4. Use the cash flow forecast formula

1. Prepare your cash flow statement 

Start by picking a timeframe for your cash flow forecast. It can be short-term, like 30 days, or longer, such as a quarter or a year. 

Then, select a forecasting method based on your timeframe. For short periods, use the direct method by looking at your known income and expenses. For longer periods, use the indirect method to project future cash flow.

Next, calculate your estimated cash inflows, outflows, and starting balance. Add up expected gains like sales revenue and investment income for inflows. Then, sum up expenses like loan payments and payroll for outflows. Finally, note the starting cash balance in your accounts.

Using a cash flow projection template can simplify the process as it shows you where to plug your numbers, so you can understand how cash moves through your business.

📚Read: What Is a Cash Flow Statement? + Free Template (2024)

2. Estimate upcoming sales 

Use past data from your financial and monthly income statements to predict cash inflows each month. If you’re a new business without a sales history, develop a sales forecast based on industry research, projecting sales for each month, not just for the year.

Then, list out how much you expect to earn per month by income type and other sources of cash, like asset sales, government grants, tax refunds, and licensing fees.‍ Add up the totals in each column to get your net projected inflows.

3. Predict business expenses

Next, estimate your fixed, variable, and one-off expenses. Fixed expenses don’t change. These include: 

• Payroll
• Rent 
• Business insurance

Variable expenses often fluctuate with your sales. These include:

• Raw materials
• Commissions
• Shipping costs

Go through your sales records to estimate expenses for each month of the next year. List out each type of expenditure or expense in the column you listed income types, then add up the expenses in each column to get your net projected outflows.

4. Use the cash flow forecast formula

Once you’ve calculated inflows, outflows, and starting cash balance, you’re ready to create your cash flow forecast.

First, calculate net cash flow by subtracting outflows from inflows. This formula reads: 

Inflows - Outflows = Net Cash Flow

Positive cash flows represent a business gain over the period of time in question, indicating that your business has more cash coming in than going out. This money can be used to invest in growth opportunities, pay off debts, or build a reserve for future expenses.

If you have negative cash flow, you're losing money. Negative cash flow can be manageable in the short term if planned for, but persistent negative cash flow means you're in trouble. You may need to reduce expenses, increase sales, or get more funding.

Next, calculate your closing cash balance, or how much cash your business is expected to have in its bank accounts at the end of the forecasting period. This number is calculated using the cash flow projection formula: 

Starting Balance + Outflows - Inflows = Closing Cash Balance

Cash flow forecasting software can automate large parts of this process, both improving the accuracy of your forecasts and making it quick and easy to consult updated cash flow projections. 

💡Use Shopify’s free cash flow calculator to understand your cash flow in under 5 minutes.

Cash flow forecast example

To help you create an accurate cash flow forecast, here’s an example to draw inspiration from and put your learnings into action. 

	January	February	March
1. Beginning cash balance	$5,000	$15,000	$4,000
Account receivables	$40,000	$30,000	$35,000
Customer cash deposits	$12,000	$5,000	$3,000
2. Total projected inflows	$52,000	$35,000	$38,000
Payroll + taxes	$15,000	$15,000	$15,000
Vendor payments	$10,000	$13,000	$20,000
Rent	$5,500	$5,500	$5,500
Loan payments	$4,500	$4,500	$4,500
Other overheads	$7,000	$5,000	$6,000
3. Projected outflows	$42,000	$43,000	$51,000
4. Ending cash balance	$15,000	$7,000	($9,000)

 

From this example, the business expects a cash shortage in March because of a negative cash flow. Knowing this in advance can help the business take measures, such as engaging more affordable vendors or finding cost-cutting measures to reduce overheads and prevent the foreseen shortage.

Cash flow forecast benefits

Cash flow forecasting provides many strategic advantages, from helping businesses pay off debt to maximizing returns on current assets.

• It can help businesses make informed decisions about cash outflow. Business owners prioritize potential investments constantly. Net cash flow can help you schedule expenditures strategically, whether it's a new hire, a marketing investment, or a facility investment.
• It can help businesses identify cash outflow patterns. Using cash flow forecasting to identify opportunities to reduce unnecessary expenses, you can track outflows. Additionally, it helps you ensure that all of your bills do not come due at the same time, so you don't have to carry too much cash.
• It can help businesses project growth or manage debt repayment timelines. Profits and losses can be anticipated over a quarter, a year, or longer. Developing a repayment timeline with cash flow projections can help your business take out a start-up loan, and reviewing monthly cash flows will help you determine if you are on track. Accrued profits are the same.
• It can help you put your funds to work. Most companies keep some cash in reserve. Beyond this, letting cash accumulate in your business bank account is unwise. You can free up funds by forecasting cash flow. You can use cash flow forecasting to invest in markets or grow your business.

Disadvantages of cash flow projections 

Keep these caveats in mind when creating cash flow forecasts.

• It can be inaccurate—particularly under an indirect method. Just like a weather forecast, a cash flow forecast represents a best guess at what future conditions are likely to look like based on current conditions and existing models. And, just like a weather forecast, cash flow forecasts can be wrong. This is particularly true for seasonal forecasts made under the indirect method. Even direct cash flow forecasting, however, can be inaccurate, as this method assumes that your debtors will pay their bills on time and that you won’t incur any unexpected expenses during the forecasting period.
• It doesn’t account for unforeseen events. Cash flow forecasting doesn’t account for a tree falling on your workshop or your cat tipping a glass of water onto your keyboard. Businesses tend to keep extra cash in reserve to deal with these surprise expenses. 
• It can be a time-intensive process. Even if you already operate on an accrual accounting method, your forecasting process will involve taking a close look at accounts receivable, accounts payable, and your balance sheet and either partitioning or extrapolating on these numbers to isolate your forecasting period—all before you begin your calculations.

Cash flow forecasting tips

So, how can you improve the accuracy of your cash flow forecast? Here are a few tips to help set you up for success:

1. Remember annual payments. Include any expenses you pay annually rather than monthly in your cash flow forecast spreadsheet. Examples include subscriptions and insurance policies.
2. Include estimated tax payments. When making your cash flow forecast, remember to include sales and non-sales income, like tax refunds in your cash inflows, and tax bills in your outflows.
3. Account for seasonal fluctuations. If you anticipate a period of lower sales, include it in your forecast so you have enough cash on hand when business picks up again. 
4. Remember savings. Allocate a portion of any cash surpluses to save for lean months.
5. Be cautious with your predictions. It’s okay to be ambitious, but take a conservative and realistic approach to cash flow forecasts. 
6. Use different layouts to provide greater detail. A detailed cash flow analysis can boost your chances of obtaining a loan or securing a large investment. Break down your annual forecast into month-by-month projections, then add each set of figures to get your annual forecast and predict net cash flow. 
7. Account for extra pay periods. Ensure your projection accounts for months with extra pay periods. For example, if you pay employees bi-monthly, your forecast should consider months with more payrolls.
8. Create a rolling 12-month cash flow forecast. Keep your forecast within 12 months. Longer reporting periods in your forecast make the process time-consuming and yield little valuable insight.

Predict the cash flow of your business

Cash flow forecasting is a valuable tool in your strategic business development arsenal. It allows you to plan for the future and evaluate your performance relative to your predictions. 

Investing in an accounting method (or accounting software) that makes generating cash flow projections possible is wise. Just remember not to mistake predictions for certainty—and keep a little cash around for those (proverbial) rainy days.

Cash flow forecast FAQ

What are the two 2 main types of cash flow forecasts?

The two main types of cash flow forecasting models are short-term and long-term. Short-term forecasts predict cash inflow and outflow over a month, quarter, or year, while long-term forecasts predict cash flow over a longer span, like five years or more.

What is the cash flow forecasting method?

Cash flow forecasting is the process of estimating cash inflows and outflows over a period of time. It's a key tool for financial planning and budgeting, as it allows a business to predict and plan for future cash needs. It also helps identify potential cash flow problems, so the business can take corrective action ahead of time.

How do you calculate cash flow projections?

To calculate cash flow projections, use the cash flow forecast formula, which looks like this: 

Beginning Cash/Cash on hand + Projected Inflows (invoices received and paid to your business) - Projected Outflows (expenses and payments) = Ending Cash.

How do you predict net cash flow?

1. Determine your starting cash balance: Look at your company’s balance sheet to determine its current cash position.
2. Estimate your cash inflows: Determine your expected cash inflows from sales, capital investments, loans, and other sources.
3. Estimate your cash outflows: Estimate your expected cash outflows from expenses, capital expenditures, loan payments, and other sources.
4. Calculate the net effect: Subtract your expected cash outflows from your expected cash inflows to calculate your net cash flow.
5. Adjust for other factors: Consider other factors that could affect your cash flow such as taxes, currency fluctuations, and interest rates.
6. Record your forecast: Record your cash flow forecast for future reference and use.

What is an example of a cash projection?

Let’s say your business has a starting cash balance of $50,000, projected inflows of $120,000, and projected outflows of $40,000. Using the cash flow forecast formula, your forecasted cash flow for the period will be $50,000 + $120,000 - $40,000 = $130,000.

How to make a cash flow forecast accurate?

To make an accurate cash flow forecast, scope out your financial plan for the forecasting period, add up all forms of incoming cash and all sources of cash outflows, and maintain the data through consistent reporting and communication. Leverage cash flow projection templates and cash flow forecasting software to automate reporting, track important business metrics, and minimize potential forecasting errors.