Forecasting Cash

Cash forecasting is the process of estimating a company's future cash inflows and outflows.

By accurately predicting cash inflows and outflows, a company can identify how much cash it will need to have at each time period so that it can meet its short-term obligations, allowing the company to determine if it will have surplus cash to invest or if it will need to raise funds.

Which methods exist?

A wide range of methods exist, and the choice of which one to use depends on the characteristics of the business and on the time horizon of the forecast. I will identify here the three types of methods that make most sense to me:

A) Historical cash forecasting

Analyzing past cash inflows and outflows provides a valuable tool for the identification of seasonal trends, event-related patterns and cash maximium drawdown.

It is relatively easy to compute. As long as the company has the cash inflows and outlfows recorded in a database, one just needs to apply simple statistical analyses. 

Actually, for businesses with stable revenues and costs, and no anticipated investment needs, historical cash forecasting may be sufficient to gain an understanding of future cash flows.

However, for struggling, shrinking or growing businesses, although a historical analysis may help in understanding cash patterns, it is not comprehensive or adequate on its own.

B) Short-term cash forecasting based on A/R and A/P

This method is to use accounts receivable as accounts payable to identify very short-term cash flows, such as 30 days (as long as it is smaller than the usual collection and payment periods).

It is only possible in a business that has a low percentage of upfront payments and receipts

For example, for a 30-day period, the cash flows can be estimated as the following:

Cash Flows = Accounts receivable in coming 30 days + Estimated upfront receipts - Accounts payable in coming 30 days - Estimated upfront payments - Estimated employee expenses - Salaries - Taxes - Capex (if not included in accounts payable nor in upfront payments)

C) Pure cash forecasting

This method can be used for projecting cash flows for any timeframe.

Basically, the idea is to use the company budget, insights from different departaments, macroeconomic forecasts, scenario analysis and other tools to forecast the company's future cash flows, namely by forecasting the company's sales, costs and capex, and its collection/payment dates.

This is an extensive exercise that consumes a lot of time, not only from the employee who is doing it, but also from the employees whom are being consulted in the process. Therefore, it may not be worth doing for stable businesses, as the outcome should not be much different from the one obtained through the historical analysis. Nonetheless, for a strugglying, shrinking or growing business, specially the ones that are not exactly cash-rich, this method is paramount.