Almost every company does some form of forecast for their P&L, but surprisingly few take the next step and create a forecast for their future cash flows as well. There are several reasons for this, but it often comes down to the fact that this process is perceived as both difficult and time consuming – which it usually is, but with the right system it doesn’t have to be.
Before we talk about how you create a proper cash flow forecast, I just want to make a point of why it’s important – what are the benefits?
The answer varies from company to company. For expanding companies that are investing money at a high rate, it’s of course very important to keep track of whether cash at hand will last until the next round of financing. For other companies, it’s about being able to minimize money they have in the bank and instead dare to use that liquidity in the business or distribute it to the owners.
"What many people don’t think about is that too much liquidity can also be a problem"
Something I hear very often when we show potential customers our solution for liquidity forecasting is ”but we don’t have a problem with liquidity…”. What many people don’t think about though, is that too much liquidity can also be a problem – and an opportunity. For example: if the owners of a company have set a required return on invested capital of 12% and the company, with the help of accurate liquidity forecasts, can keep 500,000 EUR less in cash buffer, this corresponds to a reduced cost of 60,000 EUR per year.
Instead of optimizing liquidity it’s very common that companies focus on other (often more difficult) optimizations. For example, it’s not uncommon for companies to spend a large amount of money on optimizing their logistics solutions in order to tie up less capital in the business. This is of course not a bad thing in itself, but with the help of correctly made cash flow forecasts, you can often find much easier ways to reduce tied-up capital.
To be able to forecast the cash flow you also need a forecast of the balance sheet. With a modern system for financial planning you can solve this by adding a number of KPI:s, for example: the average number of payment days for your customer- or supplier invoices or how many months of sales are stocked. The underlying framework of the system can then use this information, together with the forecasted P&L, to automatically calculate both a balance sheet and a cash flow.
"A modern planning platform can automatically create a balance sheet and cash flow"
It might seem simple – and that’s exactly how it should be perceived by the user – but the underlying framework, which for example calculates future VAT payments based on sales, COGS, investments and other costs, while taking into account the effect of prepaid income, accrued expenses, differences in rules for VAT payment for subsidiaries operating in different countries etc. – is very complex.
A strong recommendation is therefore to think twice before starting a project to build such a framework from the ground up. In this case, you have everything to gain from buying a system that already has a complete set of rules that only needs to be customized for your unique company.
With the right system for financial planning, you always have a current cash flow – which is updated automatically every time the overall forecast changes. This provides a better basis for decision-making, greater opportunities to work more actively with liquidity optimization, and you also get a solid analysis of historical cash flows.
Implementing this type of system doesn’t even need to be a big project, given that you purchase a modern forecasting tool that already has a framework for liquidity forecasts in place.
Would you like to know more about our unique system for balance sheet forecasts and automatically updated cash flow forecasts? Learn more here or feel free to contact me and we’ll book a meeting to discuss it further!
Read more about balance sheet and cash flow forecasts here, or book a meeting for a personal demo.
