Guide to Cash Flow Forecasting
What does the future hold for your real estate business? While you can’t say for sure, you can use the tools and information you have available to make an educated guess. One of the things you might want to forecast is the amount of cash that will flow in and out of your business. Cash is king in any industry. When you don’t have enough of it, it’s challenging to pay the bills and your employees. In 2015, about one-quarter of businesses that closed did so because of cash flow issues.
Not knowing your company’s cash flow can get in the way of you reaching your goals. While you want to leave some room for change and new developments in your company, putting together a cash flow forecast is often the best way to get a sense of what lies ahead for your business financially.
What Is Cash Flow Forecasting?
Cash flow forecasting estimates or projects how much money will be coming into and out of your company over a specified period. Cash flow refers to money moving to and from your business. When you receive a payment from a client, you have cash flowing into your business. When you make a payment to a contractor or purchase supplies for your company, cash flows away from your business.
In an ideal world, the cash coming in would be equal or more than the cash that flows away from your business. When you have more cash going out than coming it, your company is cash-flow negative, meaning it might be difficult to make payments or fulfill your obligations. Usually, a company with cash flow difficulties needs to pay for things on credit or delay payments as much as possible until they have enough money flowing in.
With cash flow forecasting, you get an idea of whether your business will have enough money to cover its obligations. Usually, you make the forecast using information from the past. You might look at the income from previous months or years to estimate what income will be in the upcoming months. You’re also likely to use past expenses and costs to estimate how much you’ll spend in the upcoming period.
What Is the Goal of Cash Flow Forecasting?
The goal of cash flow forecasting is to give you an idea of your business’ liquidity. There are times when your company be in the black or earning a profit but might still struggle to make ends meet or pay the bills. For example, let’s say your construction company has entered into a contract with a buyer to build a home. The buyer will pay $500,000 for the home. As long as the cost of building the house is less than $500,000, your business stands to profit.
It’s likely the buyer isn’t going to pay in full at the start of the project. More likely, the money will go into escrow, and you’ll receive payments when you achieve certain project milestones.
With a cash flow forecast, you can map out when you will receive payments and other forms of income or earnings. You can also map out when you’ll need to make payments, such as when you will need to purchase materials or pay your subcontractors and employees. You can then compare the incoming cash to the outgoing cash. Will the money coming in from the escrow be enough to pay for the expenses during that period?
It might be that based on your forecast, some months will be leaner than others. You might have more expenses than income during a particular month. It’s also likely that you’ll have more cash coming in than going out at other times. Thanks to your forecast, you can know when times are lean and when you’re likely to be flush and make plans to cover any shortages.
How Can Cash Flow Forecasting Benefit Your Real Estate Business?
Creating a cash flow forecast for your real estate business has many advantages.
- Helps you plan for shortages or lean periods: When you create a forecast, you have a general idea of what your business will earn and what it will be spending on during each month out of the year. It might be the case that some months see less money coming in than others. Or, you might have higher expenses during some times of the year compared to others. If you make plans in advance, you can see when cash might be tight and make the appropriate adjustments.
- Helps you estimate when you will have a surplus: Along with showing you times when you might have a cash shortage, your forecast can show you times when there will be more cash than usual coming in. For example, the spring and summer might be busy times for your construction company, and you might have more earnings during those two seasons compared to in the winter. If you anticipate that some seasons or months will bring in more cash than others, you can make arrangements to help cover the months when things are lean.
- Helps you see how a change would affect your company: A cash flow forecast can also help you plan for your business’ growth. You can use your forecast when developing a strategy for your company. For example, you can create a forecast to get an idea of how much your expenses will be if you hired a new team member. You can also use a forecast to determine whether or not switching vendors would make much of a difference to your bottom line and cash flow.
- Helps make your company attractive to lenders or investors: You might want to get financing for your business at some point, either from a lender or an investor. Before a lender or investor decides to work with your business, they typically want to see evidence that your business is financially viable or that it’s likely to stay afloat. Presenting a lender or an investor with a cash flow forecast sends a message that your company has potential and that it will be likely to pay back a loan or earn a profit for the investor.
- Provides insight into where you could make changes: In addition to helping you see the effect a particular change would have on your company, a cash flow forecast can help you see what types of changes to make to help your business grow. Your accounting team can create several different forecasts, showing the change in cash flow if you were to hire someone, switch vendors, expand into a new market or offer a new service.
- Helps you plan for the future: A cash flow forecast allows you to see what the future might hold for your company. With a forecast in hand, you can decide where to pivot next or determine that it’s time to grow and expand. In some cases, the information provided by the forecast can be what convinces you that it is time to close up shop and move on to your next project or company.
Keys to Accurate Cash Flow Forecasting
A forecast uses information from the past and the present to estimate what is likely to occur in the future. Since the creation of a forecast relies on information from the past, there is a chance that what takes place, in reality, differs somewhat from what was predicted. Just as meteorologists can predict a snowstorm that never happens or a hurricane that ends up traveling out to sea instead of inland, an accounting team can forecast times of shortage or surplus that never come to pass.
While you can’t guarantee that what you forecast will come to pass, there are ways to improve cash flow forecasting and to help make your forecasts as accurate as possible. Some of the things you need to create an accurate forecast are:
- Plenty of data: Although things can change based on factors you can’t predict, for the most part, historical data from your company can help you forecast what lies ahead. If you have records of outgoing cash and incoming cash that go back years, you can use the data to estimate your cash flow for the year to come.
- Open lines of communication: Whether you work with an outside financial management services company or use an in-house staff member to create your forecasts, communication must be ongoing and open. Have an understanding of who’s in charge of what information and create a plan so everyone is on the same page. Ideally, you won’t find yourself in a situation where one department is getting financing without letting the other departments know or where one team is spending more without informing other teams.
- An understanding of cash flow: You and members of your team should know what cash flow is. There are cases when people assume that “cash flow” is the money a company earns. That’s only part of the story. Your cash flow includes income from revenue. It also includes payments from a loan or from investor financing and adjustments for amortization and depreciation.
- Details about the timing of payments: Knowing when you will receive payments or cash is vital when creating a forecast. Setting up systems that ensure that you receive timely payments from your customers can help to make your forecasts as accurate as possible. For example, if you create the forecast with the assumption that people will pay bills by the 15th of the month, it’s essential that people actually pay by that date, or else you’ll see a discrepancy between the forecast and reality.
- Multiple possibilities and scenarios: When creating a forecast, it’s helpful to put together several possible scenarios. That way, if something changes, you’ll have a general idea of what the change might mean for your cash flow. For example, you might create a scenario where you hire several people, a scenario where a tariff or tax gets added or a scenario where you trim expenses and work with a smaller team. If you have multiple possibilities planned out, you’ll have an idea of to anticipate, no matter what ends up happening.
- Flexibility: Your forecast will likely be off slightly. It’s rare for a company to hit the bullseye and predict with a 100% certainty what their cash flow will be. Allowing for flexibility and giving your business space to adjust its forecasts as needed is crucial when you are creating a forecast. It might be the case that the forecast itself allows for a slight variance, such as 5%. Being flexible will help your company be more likely to weather and survive a cash flow storm.
How Is Cash Flow Forecasting Done?
Two methods of cash flow forecasting exist — direct and indirect. Whether you use a direct method or an indirect method depends on your overall goals. Typically, the direct method is better suited for short-term forecasts. If you want to know what your cash flow will look like over the next quarter or 90 days, the direct method is for you.
With the direct cash flow forecasting method, you look at information from your accounts receivable and your accounts payable. Since you’re using concrete data, direct cash flow forecasts are often fairly accurate.
With an indirect cash flow forecasting method, your goal is typically to evaluate your company’s cash flow needs over an extended period. Usually, the indirect method is used when you’re trying to determine whether to move forward with a particular strategy or not. It can help you see if your company has the available cash to take on a project or move in a new direction.
When creating an indirect cash flow forecast, you typically create a projected income statement and balance sheet. There’s a larger margin for error with the indirect method, due to the length of the period and the fact that you’re estimating your business’ activity.
Cash Flow Forecast Example
A cash flow forecast will typically have five sections:
- Cash brought forward: Cash brought forward is any cash left over from the previous period. In some cases, it can be a negative amount.
- Cash incoming: Cash incoming is any money your business will receive during the period, whether from sales, loans, investors, stocks or depreciation.
- Cash outgoing: Cash outgoing is your expenses and costs for the period.
- Cash incoming minus cash outgoing: Subtracting the outgoing cash from the incoming cash lets you see whether you are likely to have a positive cash flow during the period.
- Cash to carry forward to the next period: The cash you carry forward to the next period is the cash incoming minus outgoing added to the cash brought forward.
An example of a cash flow forecast for one quarter might look like this:
- Cash brought forward: $5,000
- Incoming cash (sales): $5,000
- Incoming cash (investor): $5,000
- Incoming cash (loan): $5,000
- Outgoing cash (building supplies): $7,000
- Outgoing cash (subcontractor fee): $2,000
- Outgoing cash (marketing fee): $2,000
- Outgoing cash (transportation): $1,000
- Outgoing cash (lease): $5,000
- Cash incoming minus cash outgoing: -$2,000
- Cash to carry forward to next period: $3,000
Top Cash Flow Forecasting Tips From Pasaban Account Solutions
The most important thing to remember when creating a cash flow forecast is that it is an ongoing process. Another tip to remember is that forecasting isn’t something your real estate business needs to do on its own. Pasaban Accounting Solutions can help you make the most of your cash flow forecast. Our CFO and accounting services will allow you to increase your company’s profitability, maintain accurate records and determine what the next best step is for your business to take. Whether you are drawing up your first cash flow forecast or are looking for advanced cash flow forecasting, contact us today.