What are the best ways to forecast cash flow in FP&A?

1 Understand the cash flow statement

The first step to forecast cash flow is to understand the cash flow statement, which is one of the main financial statements of a business. The cash flow statement shows how cash is generated and used by operating, investing, and financing activities in a given period. By analyzing the cash flow statement, you can identify the sources and uses of cash, and how they relate to the income statement and the balance sheet. You can also compare the actual cash flow with the budgeted or projected cash flow, and investigate any variances or discrepancies.

2 Choose a forecasting method

The next step is to choose a forecasting method that suits your business and your objectives. There are different methods to forecast cash flow, such as the direct method, the indirect method, and the hybrid method. The direct method projects cash flow based on the expected receipts and payments of cash from customers, suppliers, employees, and other stakeholders. The indirect method projects cash flow based on the changes in the income statement and the balance sheet items, such as net income, depreciation, accounts receivable, accounts payable, and inventory. The hybrid method combines both the direct and the indirect methods, using the direct method for the short term and the indirect method for the long term.

3 Build a cash flow model

The third step is to build a cash flow model that incorporates your assumptions, data, and calculations. A cash flow model is a spreadsheet or a software tool that allows you to forecast cash flow based on various scenarios and inputs. A good cash flow model should be simple, accurate, flexible, and transparent. It should also be aligned with your business strategy, goals, and drivers. You can use historical data, industry benchmarks, market trends, and other sources of information to support your assumptions and estimates. You can also use formulas, functions, and charts to automate and visualize your cash flow model.

4 Perform a sensitivity analysis

The fourth step is to perform a sensitivity analysis to test the robustness and reliability of your cash flow model. A sensitivity analysis is a technique that measures how your cash flow forecast changes when you vary one or more input variables. For example, you can change the sales growth rate, the gross margin, the working capital ratio, the capital expenditure, or the interest rate, and see how they affect your cash flow forecast. By doing a sensitivity analysis, you can identify the key drivers and risks of your cash flow, and how to manage them. You can also evaluate different scenarios and outcomes, such as best case, worst case, and base case.

5 Update and monitor your cash flow forecast

The fifth step is to update and monitor your cash flow forecast regularly and frequently. A cash flow forecast is not a static document, but a dynamic tool that reflects the changing conditions and realities of your business. Therefore, you need to update your cash flow forecast with the latest data, assumptions, and events, and compare it with the actual cash flow. You also need to monitor your cash flow forecast against your budget, your targets, and your expectations, and track your performance and progress. By updating and monitoring your cash flow forecast, you can spot any issues or opportunities, and take corrective or preventive actions.

6 Communicate and present your cash flow forecast

The sixth and final step is to communicate and present your cash flow forecast to your stakeholders, such as your management, your investors, your lenders, or your auditors. Your cash flow forecast is not only a tool for your own analysis and planning, but also a tool for your communication and persuasion. Therefore, you need to present your cash flow forecast in a clear, concise, and compelling way, and highlight the main insights, implications, and recommendations. You also need to explain your assumptions, methods, and results, and address any questions or feedback. By communicating and presenting your cash flow forecast, you can demonstrate your credibility, expertise, and value as an FP&A professional.

7 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?