Cash flow forecasting or cash flow management is a key aspect of financial management of a business, planning its future cash requirements to avoid a crisis of liquidity.
Why is cash flow forecasting important?
If a business runs out of cash and is not able to obtain new finance, it will become insolvent. This is no excuse for management to claim that they did not see a cash flow crisis coming. As a result, it is essential that management forecast (i.e. what is going to happen to cash flow to make sure the business has enough to survive) is performed correctly.
Reasons why a cash flow forecast is important:
- It identifies possible shortfalls in cash balances in advance.
- It makes sure that the business can afford to pay suppliers and employees. Suppliers who don’t get paid will soon stop supplying the business; it is even worse if employees are not paid on time.
- The cash flow forecast encourages the business to look at how quickly customers are paying their debts. As an important discipline of financial planning – the cash flow forecast is an important management process, similar to preparing business budgets.
- External stakeholders such as banks may require a regular forecast. Certainly, if the business has a bank loan, the bank will want to look at the cash flow forecast at regular intervals.