Forecasting cash flow: 5 Common errors
Cash flow forecasting is one of the most difficult, yet important, aspects of financial management. It’s an important tool in predicting how much capital investment is needed, and in making sure you have enough cash available throughout the year. There are many ways this process can go wrong, and ultimately, damage your organization. Below are five of the most common errors businesses make when forecasting cash flow.
1. Under-Committing Cash flow forecasting is a vital business tool and requires much attention so it should be allotted sufficient time and resources. It is generally not a good idea to delegate this task to junior-level employees who might lack the understanding of company finances, or overloaded senior staff who lack enough time to dedicate to the area.
2. Being Overly Optimistic One of the main dangers of cash flow forecasting is overestimating sales. On the flip side, organizations tend to underestimate the occurrence and impact of negative events, making it difficult to recognize and plan accordingly for potential “worst” case scenarios. You should always draft best-case and worst-case forecasts and put them to the test to better prepare for potential positive and negative impacts on cash. Stephen King from Inc. states, “With forecasting bank requirements and preparing cash flow projections, realistic views should always be taken about future prospects.” Projections should be supported by past experience and ample research.
3. Not Updating Enough It is very important to regularly compare your actual cash flow with your prediction so you can make necessary adjustments. Susan Ward from about.com states, “Keep a close eye on your cash flow, so you can forecast potential cash flow problems and take steps to remedy them.” It is unrealistic to expect a perfect cash flow projection at first; however, if you review your actual results with regularity, little significant variance will occur.
4. Lack of Communication Avoid operating within a vacuum and include all members and areas in your organization when creating a cash flow forecast. Developing these communication channels is key to creating an exhaustive cash flow projection. Staff and members of the management team should review the tentative projection and ensure that their initiatives are accounted for.
5. Late Loans If you think you are going to need a loan, it is better to get one early. A strong cash flow projection will show a loan officer that your business is a good credit risk and a good candidate for a short term loan or line of credit. People tend to overestimate the availability of loans, grants, credit and equity, and this can have a devastating impact on your business later on when you find you do not have enough funding and the bank will not offer you any grants or loans.
It is important to keep a close eye on your cash flow and forecast as realistically and exhaustively as possible. Cash flow projections are one of the most essential and effective tools an organization can create, so make sure this is at the top of your priorities to ensure healthy finances in your organization.