Cash flow planning: what it means and why it's important

Understanding and effectively managing your cash flow is the key to longevity and success. But how can you ensure that your cash flow remains healthy and predictable?

Today, we will demystify cash flow planning, guiding you through how to create a cash flow plan, including the benefits and challenges. We’ll also outline the different types of cash flows and how to create a pro forma cash flow statement.

What is cash flow planning in business? 

Let’s define cash flow planning in business, and how it differs from budgeting, so you can choose the process that best aligns with your organizational goals.  

Cash flow plan definition 

Cash flow planning in business involves matching funding sources with capital needs. Cash flow planning should consider both short- and long-term needs and forecast three to six months into the future. Metrics that can be monitored as part of a cash flow plan include:

• Days sales outstanding (DSO)
• Days payables outstanding (IPO)
• Days inventory on-hand (DIO)

It’s also worth noting that cash flow planning and cash flow forecasting are often used synonymously to describe the process of managing liquidity.

Cash flow planning vs. budgeting

Budgeting accounts for revenue and expenses over a long period, usually 12 months or longer. In contrast, cash flow planning is an estimate of cash inflows and outflows over a shorter period, typically three to six months.

A budget shows income and expenses for a 12-month period, a cash flow forecast breaks down when cash will be spent or received. Both budgets and cash flow plans are vital to ensuring you have funds on hand to mitigate disruption, and drive performance.

3 steps to create a cash flow plan

Now that you understand what cash flow planning is, and how it differs from budgeting, let’s dive into the three steps to create a cash flow plan. 

1. Collect, organize, and verify all revenue & expenses

First, determine the desired time period for your cash flow plan – this can range from a few weeks to many months.

Once you’ve established how far into the future you’d like to plan, you should collect, organize, and verify all your revenue and expenses for a historical period of the same duration. This will help you better understand seasonality, recurring expenses, and payments.

Then, you can begin listing your income (cash inflows) for the period you are planning for. This list should include anticipated sales but also non-sales income, including tax refunds, grants, investments, and royalties or license fees.

Next, you should list your expenses (cash outflows) for your desired period. This should include all the expenses associated with running your business, including rent, salaries, loans, marketing and advertising, and more.

Your cash inflow and outflow data can be automatically aggregated from your FP&A software (also referred to as Financial Planning, Corporate Performance Management (CPM), Financial Performance Management (FPM), or Enterprise Performance Management (EPM) software). If you’re still using spreadsheets, you must compile this data manually, which puts you at risk of introducing errors. 

2. Calculate the cash balance for each month 

Once you have a list of your cash inflows and outflows, you can begin calculating your cash balance for each month by subtracting your expenses from your income.

This will help you determine if you have a positive cash flow, which means you are bringing in more income than you’re spending, or a negative cash flow, which means you’re spending more than you’re bringing in.

In each case, you can adjust your targets to meet the needs of the business, and ensure you have enough cash on hand to meet your commitments. 

3. Estimate future cash flows 

Once you’ve calculated your cash balance for each month, it’s easy to estimate your future cash flows over many months.

If you have too many positive or negative cash flow weeks in a row, this may indicate it’s time to invest your surplus funds or adjust sales targets or payment periods to generate more cash inflows.

Benefits of cash flow planning 

Let's explore how cash flow planning can enhance your business, from bolstering cost control to avoiding financial obstacles and optimizing receivables.

Stronger cost control

When you know what money is coming in and going out, it's easier to see where your business is spending. By looking at how you spend, you can find places where you're wasting money and decide where to spend less. This helps you control costs better, making the most of what you have and keeping your business healthy.

Prevent roadblocks 

Cash flow planning helps you sidestep financial roadblocks. By forecasting your finances, you can anticipate and navigate around potential cash shortages. This allows for uninterrupted business operations.  

Optimize receivables

Effective cash flow planning not only enhances your control over incoming payments, but also allows you to identify and address issues with customers who are frequently late on payments. By accurately predicting and tracking payment schedules, you can maintain a steady cash inflow and work proactively with clients to ensure timely payments. This strategic approach helps prevent financial hiccups and fosters stronger customer relationships, leading to more efficient and productive receivables management.

Challenges associated with cash flow planning 

There are complexities to cash flow planning and potential challenges like inaccurate data, lack of departmental participation, and the element of uncertainty. But there are practical solutions to overcome them

Inaccurate data

If you’re using spreadsheets to track and manage your cash inflows and outflows, you may struggle with inaccurate data during the planning process. This can lead to flawed cash flow forecasts, causing potential missteps in strategic decision-making.

To address this, we suggest FP&A software that can help you set up automated calculations that feed into your cash flow budgets, like cash from operations or investments. Once the automated changes are in place, you only need to account for cash activities that aren’t automated, like certain financing or investment activities. 

Lack of departmental participation 

Not having all departments involved can make planning cash flow harder. Without full cooperation, finance teams can miss important information, making cash predictions less accurate. To fix this problem, all departments need to work together.

To promote cross-company collaboration, we recommend implementing financial planning software. Financial planning software can streamline information sharing across all departments, ensuring no important data is missed. As a result, the finance team receives comprehensive input for more accurate cash flow predictions.  

Not a guarantee

While cash flow plans are helpful for finance teams looking to understand their cash position, it’s not a guarantee of what’s to come.

To address the challenge of cash flow plans not guaranteeing future outcomes, consider adopting a scenario analysis approach. This involves creating multiple cash flow forecasts based on different possible scenarios - such as delayed payments or unexpected cost increases. By preparing for various outcomes, you can better navigate and adapt to unexpected financial changes, enhancing your company's resilience.

What are the different kinds of cash flow? 

Let’s unpack the intricacies of distinct cash flows - cash flow from operations (CFO), cash flow from investing (CFI), cash flow from financing (CFF), and free cash flow - and how each play a pivotal role in a company’s financial performance.  

Cash flow from operations (CFO) 

Cash flow from operations (CFO), also referred to operating cash flow, is a measure of how much cash a company generates and consumes from carrying out its operating activities during a specific period. Operating cash flow does not include investment revenue, expenses or long-term capital expenditures. 

Cash flow from investing (CFI) 

Cash flow from investing (CFI) refers to cash earned or spent as part of investment-related activities in a specific period. Investing cash flow can be from earned interest or from the sale of investments, or the purchase of long-term assets such as property, plant, and equipment.  

Cash flow from financing (CFF) 

Cash flow from financing (CFF) refers to the cash that is used or generated from financing activities. Financing activities can include issuing and repaying debt and issuing and buying back equity.  

Free cash flow (FCF) 

Free cash flow is used to denote the cash that is leftover after the company has paid for operating expenses and capital expenditures (also referred to as CapEx). When you have a surplus of free cash flow, your finance team can prioritize and invest in activities that increase shareholder value and expand business operations.

Creating a pro forma cash flow statement 

Now, with a solid understanding of the various types of cash flows, we can turn our attention to pro forma cash flow statements and their role in effective cash flow planning.

What is the statement of cash flows? 

A cash flow statement is a report that includes each of the cash flow types we identified above, including cash flow from:

• Operations
• Investing
• Financing

It is a holistic view of your company’s cash in and outflows during a specific period. The available cash you have indicates your ability to operate in the short- and long-term and can be compared against other financial statements including profit & loss (P&L) and income statements, and your balance sheet.  

Why create a pro forma cash flow statement as part of a cash flow plan? 

“Pro forma” is defined as “for the sake of form,” which in finance and accounting means that the financial statement was formulated using projections and assumptions. In practice, this allows companies to exclude any one-time transactions that they feel are outliers, and thus obscure their results. Pro forma cash flow statements are not usually compatible with generally accepted accounting principles (GAAP), but that does not mean they’re inherently incompatible.

As a result, the use of pro forma financial statements requires transparency about the methods used and differences from GAAP to avoid misleading investors and other stakeholders.

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Conclusion: Master cash flow planning with Prophix 

To wrap up, cash flow planning is key to business success. We’ve outlined the concept of cash flow planning, demonstrated how to create a cash flow statement, underscored its advantages, and tackled potential obstacles. So now, you can better manage your business's financial future with confidence and precision.

Ready to explore cash flow software solutions? Check out our blog on 16 best cash flow software for busy FP&A teams in 2024.