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In life, everything must be balanced; and the advantages and disadvantages of cash flow forecasting are no different. Cash flow forecasting is the process of estimating the future financial position of your company. As a core component of planning and financial management, cash flow is a powerful business KPI primarily based on your projected receivables and anticipated payments.
Because there are both advantages and disadvantages of cash flow forecasting, it’s imperative you make decisions by carefully weighing all of your options. Let’s take a closer look at some of the core advantages and disadvantages of cash flow forecasting.
The advantages of cash flow forecasting can be monumental and give you valuable insight into tomorrow to influence decisions today. Here are a few key benefits of accurate cash flow forecasting.
When you create a cash flow forecast, you’ll be able to model and understand the impact of future plans as well as potential outcomes. For example, a late payment from a client can send most small businesses into an epic crisis. However, when you accurately forecast different scenarios, you can plan for the “what ifs”, which can offer you a superior peace of mind and help you confidently put plans in place.
In business, surprises are almost always bad, which is why savvy business owners use cash flow forecasting to anticipate cash gaps before they hit. When you do, you can proactively create a plan, such as finding alternative finance options, proactively searching for lines of credits, reducing the payment terms, or other steps to close the gap.
Every business owner likes to see excess cash in the bank account. But what should you do with this cash? Should you double up on loan repayment, reinvest in new markets, or increase marketing budgets? What you do with this cash can be critical to keeping your business a float. Understanding when you’ll have a cash surplus and knowing when and where it will occur means you’ll be able to effectively plan on what to do with the surplus.
If you have plans for growth, a cash flow forecast can provide you with the insight to confidently move forward with strategic initiatives. You’ll be better equipped to know whether your business has cash to fund your growth or if you should consider outside financing sources.
A good cash flow forecast will empower you to know where and when your cash inflows come. You will also be able to quickly answer where your outflows are going. With this information compiled, you can purposefully make decisions to cut down on costs, manage labor costs, and competitively price your services and products in a sustainable way to weather potential storms.
Even though cash flow forecasting can be used to guide managers and help create business budgets, it’s important you understand some of the potential shortcomings of these projections, which can include:
No matter how much and reputable your information is, all forecasting is an educated guess. An even the best and most educated guesses involve a degree of probability. The longer your cash flow forecasting extends, the more likely it will be wrong. Because of this, the best long-term cash flow forecasts have integrated “what-if” scenarios, decision trees, and a minimum of one contingency plan. In either case, the nature of guessing is a huge disadvantage to forecasting.
In life, anything can happen on any day. And those random instances of possibility can all have an impact on business. It should come as no surprise that your cash flow forecast can be significantly impacted by factors outside of the company. For example, new government laws can quickly cause your cash flows to change — for the better or worse.
Other common blindside factors can include an increase in competition or technological changes. In the wake of any number of unforeseen factors, companies who are expecting a certain cash flow may have to quickly adjust their projections and expectations. Simply put, you can’t plan for what you don’t know and being blindsided by unforeseen factors is a disadvantage of cash flow forecasting.
Relying on long-term cash flow projections can cause business owners to make potentially costly and inaccurate business decisions. For example, if you commit to making a capital investment in your business — like purchasing a fleet of vehicles — based on cash-flow projections, and your projections fall short, your business is likely to suffer serious implications. This could force you to take on more debt to cover this financial projection shortfall, which could force your business into even more strain and peril.
If you’re a startup business, new business or a business that doesn’t have a few years of data, cash flow forecasting can be a problem. In most instances, businesses who successfully forecast cash flows rely on historic business information and industry trends. While newer businesses can create forecasts based on market indexes, industry statistics, and consumer research; this information is broadly based and not specific to your business. Unavailable, limited, or not-entirely-accurate information can lead to catastrophic cash flow forecasting.
When it comes to weighing the advantages and disadvantages of cash flow forecasting, the upside will almost always win. However, this doesn’t mean you should just ignore the disadvantages. Instead, you should understand the potential negative ramifications and integrate these scenarios into your projections. By doing so, you’ll enjoy a seemingly unlimited upside with sound protection for the likely or unlikely down side.
Cash flow forecasting isn’t easy. Most importantly, inaccurate cash flow forecasting can spell disaster and ruin for your business. Because of this, savvy business owners partner with John F. Dennehy CPA for accurate and reliable cash flow forecasting services. We are a team of experience CPAs, accountants, and financial business planning professionals who can help you see your business future in a new light.
Contact us today to schedule a business cash flow forecasting consultation.