Financial planning is vital for organizations that want to cement their success and ensure their future is a bright one. Many argue that cash flow based financial planning is the most effective way to plan and manage resources by focusing on the amount of cash coming in and going out of a business.
But why is the cash flow-based approach to financial planning so important? And what does it involve?
Keep reading to uncover the answers to both of these questions and more…
Topics covered in this article:
- What is cash flow-based financial planning?
- The benefits of cash flow-based financial planning
- What you need to create a cash flow plan
- The process of this type of financial planning
- How to improve the accuracy of your plans
What is cash flow-based financial planning?
Cash flow-based financial planning focuses on managing a business's cash inflows and outflows to achieve financial stability and meet financial goals.
Sounds fairly simple, right?
Well, it is… except it requires more precise data than, say, goals-based planning, which identifies financial goals, assesses the existing financial situation, and develops a plan from there. Goals-based planning is often better suited for individuals, whereas cash flow-based financial planning caters to businesses.
Cash flow-based financial planning forecasts future cash flows, which involves analyzing current and expected expenses, and identifying potential sources of income.
The main goal of this type of financial planning is to ensure that there’s sufficient cash available to meet short-term and long-term financial obligations. It’s also used to help take advantage and seize opportunities to cut costs and increase profits.
When done right, this type of financial planning helps businesses manage finances more effectively, providing a clear understanding of the business’s financial situation. In turn, this helps members of the C-Suite (such as the CEO and CFO), make informed decisions about how to best allocate company resources.
What are the benefits?
There are several benefits to using cash flow-based financial planning to forecast and manage the amount of cash coming into and going out of the business, including:
- Improved cash management
- Enhanced flexibility
- Better decision-making
- Smarter risk management
- Better management of cash reserves
- Increased ability to borrow
- Improved financial stability
- Increased profitability
What do you need?
A cash flow plan outlines a business’s expected cash inflow and outflow over a set period of time, but what do you need to create one?
Here are some key elements to create a solid cash flow plan for a business:
You’ll need to gather and review the business's financial statements. This means getting your hands on the company’s income statements and balance sheets to get a clear picture of its current financial status.
A budget will help you forecast future cash inflow and outflow by projecting revenues and expenses.
Cash flow projections
You’ll need to create detailed projections that include the business's current financial status, budget, and any anticipated changes in cash flow.
A break-even analysis helps you determine the point at which the business will start generating positive cash flow.
A sales forecast anticipates future revenue and makes more accurate cash flow projections.
List of all sources of income and costs
If you want to develop a complete picture of how money flows into and out of the business, you’ll need to identify all of the company’s sources of income and costs.
It's important to set the right timeline for each step of the cash flow plan to effectively track progress and make any necessary adjustments.
A contingency plan will help you prepare for unexpected changes in finances. It'll also make it easier to mitigate any potential negative effects on the business.
Communication and collaboration
To effectively manage cash flow, it's important to involve all relevant stakeholders in the cash flow planning process, including management, finance and accounting, and any external financial advisors.
Regular monitoring and updating
Finally, the cash flow plan should be regularly monitored and updated to ensure that it remains accurate and effective in helping the business manage its finances.
Having all this information together in a comprehensive and easy-to-understand format puts you (and senior management) in the best position to make the right decisions for the business and to make sure it’s always on a good financial footing.
What is the process of cash flow-based financial planning?
The process of this type of financial planning involves collecting and analyzing financial data, forecasting, developing, and implementing a plan to manage resources, and monitoring the plan to ensure its success.
Although the process may differ from company to company, there are a few similar steps that most finance teams take when developing a cash flow plan:
Step 1. Gathering information
The first step is to gather all relevant financial and operational data. Make sure you have all of the information ready and waiting, such as data about the company's income, expenses, assets, and liabilities. This can include data on sales and revenue, costs of goods sold, operating expenses, and other key financial metrics.
Step 2. Forecasting cash flow
Once the necessary data has been collected, the next step is to use it to forecast the company's predicted finances for a specific period of time, such as the next year or even several years into the future. This can be done using a variety of forecasting techniques, like financial modeling or scenario analysis.
Step 3. Developing a plan
Based on the forecast, you can then develop a plan for managing the company’s financial resources. This usually involves identifying areas where the company can reduce costs or increase revenues, as well as identifying opportunities for investment or expansion.
Step 4. Implementing and monitoring the plan
The final step is to implement the plan and monitor its performance. You can do this by regularly reviewing financial reports and adjusting the plan as needed.
How to improve the accuracy of your cash flow plans
Financial planning is an important part of financial management for businesses of all sizes. By creating and regularly reviewing a cash flow plan, you can identify potential issues and take steps to address them before they become serious problems.
If you want to create better cash flow plans, you must set a realistic budget. Don’t over or underestimate how much money is available. Instead, create a budget that accurately reflects the business's expenses and income.
You also need to monitor cash flow regularly. Don’t create a plan only to put it aside until the next reviewing stage. Keep track of the company’s financial health on a regular basis, such as weekly or monthly. This will allow you to identify any potential issues early on and take action to address them.
If the business is struggling finanically, look for ways to increase revenue, such as by expanding your product or service offerings or finding new customers.
Finally, remember to plan for seasonal fluctuations. If your business experiences fluctuations in cash coming in and out of the business due to the seasonality of your industry, make sure to plan ahead and have a strategy in place to manage those fluctuations.
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