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All Your Questions About Cash Flow Modeling Answered!

IR Media

Written by IR Media


Cash is the beating heart of any successful business, and for most organizations, cash flow will have the most impact on performance and longevity. Some businesses fail, but most businesses who have collapsed by the 3-year mark can usually attribute their failure to poor cash flow management.

Underestimating the importance of cash flow modelling can weaken the sustainability of an organization, so it's crucial to understand from the outset how a cash flow model works and why you need one.

What is a cash flow model?

Cash flow modelling creates visibility into a company's assets, income, expenditure, debts and investments as an indicator of its future business performance, and its most important business goal; solvency.

Cash flow modeling enables businesses to plan for the future, as well as potential market fluctuations, and even an economic recession.

Every business's cash flow modelling strategy is different, so it's impossible to create a one-size-fits-all strategy execution, but a cash flow forecast model should start by taking into consideration three crucial factors:

  1. Beginning cash balance: The total cash on hand you expect to have at the beginning of the month.
  2. Cash inflows: The cash coming into your business from operations, investments, or financing (through debt or equity).
  3. Cash outflows: All of the cash being spent through the business, including utilities, loan payments, rent, payroll, taxes, and all operating expenses. 

The most effective cash flow forecasts always include current information, as well as a variety of possible future scenarios. To achieve this, businesses need complete access to insights, data and analytics.

Full visibility on cash flow empowers businesses to plan for the future, anticipate potential issues and avoid reliance on loans and credit card debt.

Read our guide to monitoring and improving cash flow visibility here

What is cash flow forecasting?

A cash flow forecast helps a business plan for the future. A good cash flow forecast model estimates a business’s future financial position and helps ensure that it will have the necessary amount of cash to meet future obligations and better manage working capital.

Key financial reports such as an income statement (or profit and loss statement) only looks at sales and expense activity, while a balance sheet reports on assets, liabilities or contributions of equity.

A cash flow forecast on the other hand includes all movements of cash in and out of a business within a given time period. This helps ensure there is enough operating cash flow, and that the working capital is managed as effectively as possible.

How can cash flow forecasting benefit a business?

Business owners make difficult financial decisions every day. Cash flow forecasting is an essential part of business planning for a number of key reasons, and can help relieve the burden of cash flow management. The main advantages of a good cash flow forecast model include:

Scenario planning

Late payments from customers and clients can affect cash flows enormously. But modeling alternative scenarios can help businesses to understand future plans, possible outcomes, and how various situations will impact their cash inflows.

Monitoring overdue payments

While consistent overdue payments can dearly affect a business, having insight into later payers, and the impact they have on the bottom line can help formulate plans for more effective credit control.

Managing surplus cash

For many businesses, it’s rare to see excess cash in the bank, but utilizing additional cash for reinvestment in new markets, or for the repayment of loans, can be essential to maintain actual cash flow.

Tracking whether spending is on target

Every business has revenue goals and targets that are time-sensitive. But cash forecasts can help a business owner to understand exactly when and if they will reach those goals, and increase the accuracy of future budgeting.

Keeping investors and stakeholders informed

Good governance is vital to the success and longevity of any business. A detailed cash flow model forecast offers additional insight into the potential of a business encouraging confidence and the reassurance that their investment will be safe.

Identifying potential problems

With forecasting as part of your cash flow model, you can anticipate surpluses and shortages to help with decision making about whether to increase focus on collections, or to seek a line of credit.

Forecasting helps manage all aspects of a business's financial position, including how much cash is coming in from revenue streams, where it’s being spent on operating expenses, and the number of funds available after fulfilling these obligations.

Cash flow forecasting can help navigate the current climate within an industry and help businesses prepare for cash shortage situations like holidays & vacation periods that could affect a company’s bottom line.

The ability to forecast cash flow enables organizations to stay ahead of cash flow needs by identifying when more capital is needed to cover expenses and payroll commitments.

Financial analysis, planning and budgeting

A robust system for managing income and expenses is crucial for any business. A cash flow forecast can be complicated, because it involves measuring and monitoring many variables - and making predictions about performance.

But businesses need a sturdy financial model to know how much money is cycling through the company at any given time, and what cash is expected, to create a budget. Budgeting gives a detailed view of what income and capital expenditure a business can expect, and what might need to be cut.

Business leaders should spend time with their finance and accounting department as they build their financial model. It's essential to have a full understanding of accounts receivable and accounts payable. Here are some things to review:

  1. Variable costs (labor and raw materials, for example)
  2. Fixed costs (rent, utilities, certain salaries and business insurance)
  3. Other significant expenses (investments in equipment or software).

Enhanced analysis and a regular examination of cash positions will increase the accuracy of of a business's financial position.

Managing seasonality

Many businesses experiences some seasonality. There could be months when clients are more active in purchasing a company's products or services. Seasonality can have a material effect on expected future cash flows. A good cash flow forecast will anticipate when cash outflows and cash receipts are higher or lower, allowing better management of the working capital needs of the company.

For example, a retailer specializing in swimwear and accessories would obviously experience a higher selling season throughout Spring and Summer. But with the store open all year round, the business will still incur operating expenses such as rent, utilities, and labor.

This means that sales and profits during the summer months must be enough to cover all annual expenses, including working capital to purchase goods (inventory) to sell in the coming selling season. It’s the timing of these transactions that makes budgeting decisions especially complex. 

A detailed view of a cash flow statement shows the timing and amounts of revenue and expenses that affect cash flows.

How often should a business do a cash flow forecast?

Cash flow is a changing metric, and it needs to be monitored frequently over a given period. build cash flow forecasts for the short (weekly or monthly), medium (quarterly) and long (yearly) term. The needs of the business will dictate which time frame is the most valuable. A monthly cash flow forecast is recommended by financial experts at the very least, but possibly more frequently in times of economic instability.

A monthly cash flow forecast, or quarterly forecasts are generally more useful for stable, established businesses. Weekly projections will be essential for companies scaling up or going through significant changes, such as a restructuring or merger/acquisition.

What is Discounted Cash Flow (DCF)?

Discounted cash flow is a method used to estimate the value of an investment based on its expected future cash flows. DCF analysis attempts to determine the current value of an investment, based on projections of how much money it will generate in the future. The present value of expected future cash flow is determined by using a discount rate to calculate the DCF.

Cash flow modeling

This applies to the decisions of investors in companies or securities, for example when acquiring a company or buying a stock, and for business owners and managers looking to make capital budgeting or operating expenditures decisions. If the discounted cash flow is above the current cost of the investment, the opportunity could result in positive returns.

Why cash flow analysis is vital

Business leaders look at cash flow numbers as an indication of how well -or how badly - their business is performing. Cash flow analysis reveals any patterns or trends that can help address deficiencies or expand on strengths within a business.

Read our detailed report on why every business should do cash flow analysis here

Cash flow modeling

Image source: Wall Street Mojo

The importance of insights and analytics in cash flow modeling

Organizations who have visibility into their current and projected liquidity positions are undoubtedly in a better position to manage business continuity than those who don't.

With real time dashboards to display live data, analyzing cash flow is as easy as pressing a button to generate reports. Senior management can then use this data to provide them with the tools to make better informed financial and risk assessment decisions.

IR Transact simplifies the complexity of managing modern payments ecosystems, bringing real-time visibility and access to your payments system.

Businesses can gain unlimited access and insights into money flows, customer usage data, and end-to-end transaction performance metrics, offering a thousand points of reference, from a single point of view.

The ability to view an organization's entire payments ecosystem provides management with solutions to problems, which ultimately leads to an increase in profitability.

Learn more about why monitoring improves cash flow analysis here.

Topics: Payments Payment processing Transact Transaction analytics

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