Most leaders at small and midsize companies agree that managing cash flow is key to ensuring the smooth day-to-day operations of your business.
But cash flow management can benefit so much more than just the day-to-day. For one, cash flow statements help lenders determine solvency and investors assess a company’s potential. Taken one step further, cash flow projections can help you proactively manage your company finances and invest in future growth.
Cash Flow Projections vs. Financial Forecasting
It’s important to note that financial forecasting differs from projecting cash flow. A financial forecast uses historical data to predict outcomes, while a cash flow projection illuminates the effects specific potential decisions will have on liquidity. The latter offers a more accurate and data-backed perspective to drive the most effective business decisions—and, as such, can be deployed to help support sustainable, long-term growth planning.
How Scenario Analysis Fuels Cash Flow Projections
The most timely and profitable business decisions are supported by accurate financial data, with cash flow projections at the core. But why are cash flow projections so beneficial to long-term planning? In part, it comes down to one of the key processes that underpins cash flow projections—scenario analysis.
More than a simple statement, cash flow projections incorporate scenario analysis, which forecasts different outcomes based on the potential results of certain investment and business decisions. In turn, business leaders can use scenario planning to prepare for a variety of outcomes and make nimble decisions.
A scenario analysis tests both your assumptions and your goals along three axes:
- Best case: The optimistic view, in which all revenue meets or exceeds expectations, expenses occur only as planned and overall market conditions are favorable for your industry and company.
- Worst case: The pessimistic view, in which an unexpected expense or an unpredictable event might upend market conditions. For example, no one could have predicted the container ship the Ever Given would have gotten stuck in the Suez Canal, but the blockage immediately affected businesses worldwide. Cash flow projections using scenario analysis let you explore the impact of random or extreme incidents.
- Likely case: The realistic view, in which revenue is reliably achieved in a manner that can cover any unexpected expenses. For instance, a sudden spike in sales will likely usher in a concurrent rise in staffing costs and materials acquisition.
Scenarios let you change multiple inputs at once, making it easier to consider the full ramifications of potential business decisions and adjust your cash flow projections as needed.
Rolling Cash Projections: Taking Your Projections to the Next Level
While scenario analysis and its inputs are key to projecting cash flow, these projections are only as good as the data they contain. That’s where rolling projections come in. In this instance, “rolling” means “continuously adjusted.” Compared to a static one-off prediction, a rolling projection provides long-term stability.
Rolling cash flow projections offer many benefits over one-time forecasts, including:
- Improving operational performance and financial planning by making your company more agile, adaptive and able to respond to market fluctuations.
- Increasing the accuracy of your financial data, as rolling projections account for changes as they go. For instance, if revenues suddenly surge, the rolling projection reflects the change.
- Diminishing the risk of short-term cash flow issues since they more accurately predict up-to-date liquidity needs.
- Reducing the effort needed to create in-house budgets since market fluctuations and trends are regularly accounted for.
Rolling cash flow projections update regularly after a set period, the length of which depends on your current business needs and goals. Companies that need to manage liquidity carefully to meet near-term financial commitments might choose a short-term rolling projection—for instance, every two to four weeks.
Most often, rolling projections follow a 13-week projection cycle, balancing immediate financial obligations with a chance to assess future needs and decisions. Projection periods can be longer—up to six months when immediate liquidity isn’t an issue—but generally not longer than that, as the goal is to keep updating the projection with real-time data.
Putting Cash Flow Projections Into Action: Uncover Shortfalls and Opportunities
Whether your company is preparing to hire, exploring new product development or securing funding, your cash flow projections are essential for your strategic growth planning.
Consider the value you can gain from the historical data included in projections. This data creates a valuable record of past industry patterns and trends. Studying those trends helps you refine your predictions for the future. By providing transparency into your current financial status and capacity—such as by pointing out coming shortfalls—your projections help you anticipate any potential need for capital. Equally, any excess in cash flow projections can signal the most opportune moments to reinvest in the business.
Also, lenders require a thorough understanding of financial capacity before making funding decisions. According to the SEC, investors often use cash flow projections as a proxy to envision earnings.
Share Your Projections for Company Cohesion
Your cash flow projections help leadership understand the company’s financial obligations and potential. But executives aren’t the only ones who benefit from familiarity with the larger financial picture. Sharing cash flow projections with key personnel improves intra-company collaboration.
When companies give department heads access to cash flow projections, they can share the financial realities with employees. Everyone then has the same understanding of how cash flow fits into the company’s goals. That understanding leads to better spending decisions across departments, including in relation to hiring, purchasing and more.
Common Challenges To Avoid
Optimal cash flow projections ensure you can meet all your commitments, satisfy investors and invest in the right opportunities. But no cash flow projection model or example is 100% accurate every time. While there’s a chance of error with every method or model, here are some considerations to help you overcome obstacles and make your cash flow projections as targeted and applicable as possible.
When creating your cash flow projection, avoid:
- Overestimating revenue: Conservative revenue assumptions are always the best choice when creating cash flow projections. For “conservative,” think accurate, backed by data, and weighted with realistic expectations, not worst case scenario.
- Underestimating expenses: Costs can change rapidly. Your current expense data is the foundation for your cash flow projection. It requires a thorough understanding of changing market conditions and inflationary pressures.
- Using obsolete data: Your cash flow projections are only as good as the data you used to build them. Historical data is a solid start, but relying only on past data limits the potential of your cash flow projection model. Industry payment cycles and market trends can change quickly. Always look at the present and into the near future to anticipate what might happen next.
Other challenges that can interfere with cash flow projections include human error, missing or inaccurate data, or the inability to perform the required financial analysis. Today, many tools exist to automate data collection, reduce human error and provide structure for the models that work best for you.
Make Cash Flow Projections Work for You
Cash flow projections are an asset to your larger financial strategy when planning for sustained growth. Mastering cash flow projections allows businesses to stabilize cash flow, mitigate future risks, improve employee collaboration and increase financial flexibility.
If you need help improving your cash flow projection process, Paro can match you with an experienced fractional CFO to fine-tune your projections.
