The 5 Mistakes in Cash Flow Forecasting (and How to Avoid Them)
For businesses of any size, cash flow can be tough to predict. That’s why forecasting is an essential management tool to help make smart decisions on future business expenditures, resource allocation and growth planning. But for growing businesses dependent on working capital for purchasing, business development and hiring, it is vital tool in ensuring their survival. While most business owners understand the importance of cash flow forecasting, there are several ways the process can go wrong and threaten the viability of their business. Here are five common mistakes business owners make when forecasting cash flow:
Forecasting in the Rear-View Mirror
Businesses commonly base future expenditures on past results, simply moving their numbers forward and sometimes adding a small percentage increase. Unfortunately, this doesn’t account for the unexpected, such as potential payment delays that can occur when taking on new customers or project delays due to factors beyond their control. While past experience is important in forecasting, businesses need to account for the unknown and test for what-if scenarios to ensure they can cover their overhead.
Delegating the Task of Forecasting
As an essential business management function, cash flow forecasting requires the full attention of top management to ensure sufficient time and resources are allotted. However, it’s not uncommon for the task to be delegated to underlings, who often lack the necessary skills and insight to produce an accurate forecast. Instead, make it a collaborative process in which junior staff creates initial estimates for the senior staff to review and finalize.
Not Questioning Your Forecasts
Forecasts are only as good as the assumptions—and a bad one can have a negative multiplier effect on your projections. One of the more common mistakes is to overestimate sales, which often leads to a cash shortfall. That’s why it’s essential to regularly question your team’s forecasts, especially as they relate to sales and expenses.
According to a survey of accounting and tax leaders by Bloomberg BNA, nearly one third of all financial reporting errors is due to manual input of data. One wrong entry can have a ripple effect compounding the inaccuracy of all the financial reports that feed into a cash flow forecast. Before creating a forecast, double-check all figures in your cash flow and income statements. With financial management software, your entries can be automatically reconciled to reveal any mistakes.
Failure to Update Forecasts Frequently
Perhaps the biggest mistake many businesses make is creating the “perfect” forecast and then setting it and forgetting it. Business owners know that their businesses are unpredictably dynamic, with something happening every week that affects cash flow. Forecasting should be a continuous activity with frequent adjustments that reflect where your finances are at any given point. If you regularly compare your forecast to your actual results, there will always be minimal variance along the way.
For growing businesses, everything affects your cash flow. And cash flow forecasting is a must-have management tool. With proper forecasting, you can confidently keep your business running smoothly.