CEO, do you forecast your company’s finances based on the bank account balance or cash flow?

Financial management is a critical aspect of business success, with a key role in understanding and managing cash flow. Many entrepreneurs or CEOs may monitor their company’s finances based on the bank account balance, but this can only provide a snapshot of the company’s current financial position. While the bank account balance shows how much money is available right now, cash flow reveals whether the company can meet future payments and investments. This article delves into why monitoring cash flow is crucial for forecasting and maintaining financial stability.

Additionally, it’s important to remember that no financial management system can provide an up-to-date view of your company’s cash flow unless all information from every transaction has been correctly input. Therefore, understanding your company’s cash flow thoroughly is essential. There are countless ready-made models and examples available to help with this. However, when modeling your own cash flow, ensure you apply the most accurate and practical framework suited to your specific needs to avoid errors.

What does cash flow mean?

Cash flow refers to the movement of money in and out of a company—that is, how much cash the company receives (from sales, loans, investments) and how much cash flows out (expenses, salaries, loan repayments). Cash flow can be divided into three main categories:

  1. Operating cash flow: This includes the company’s daily operational income and expenses, such as payments received from customers and employee salaries.
  2. Investing cash flow: This reflects cash flows related to investments, such as the purchase or sale of machinery and equipment.
  3. Financing cash flow: This category includes cash flows related to financing, such as taking out loans, repaying debts, and paying dividends.

Combining all these areas provides an accurate picture of how the company’s cash is moving and reveals the company’s true liquidity for the future. Unlike just looking at the account balance, cash flow gives insight into the business’s financial situation from multiple perspectives and helps predict whether the company will have enough funds to meet future obligations. Most importantly, it helps avoid unpleasant surprises.

Why is cash flow more important than the bank account balance?

While the bank account balance may seem like an appealing and straightforward way to look at a company’s financial situation, it does not tell the full story. Preparing cash flow forecasts offers a much deeper understanding of the company’s viability, and it holds the key to avoiding financial risks. Here are some reasons why monitoring cash flow is more important than just looking at the account balance:

  1. Account balance is momentary

A company’s bank account balance only shows its current cash position. For example, a company may have a large balance immediately after receiving payments from customers, but if bills and salaries due in a few days exceed the balance, the company could face liquidity issues. Cash flow, on the other hand, considers future income and expenses, allowing the company to prepare for upcoming obligations in advance.

  1. Cash flow forecasting predicts the future

With cash flow forecasts, a company can assess its future financial needs. Cash flow analysis is an excellent tool for evaluating and managing liquidity. It reveals whether the company has enough funds for upcoming expenses, such as loan repayments or major investments.

  1. Growth and investments require predictability

A company’s growth requires investments, which in turn demand accurate cash flow forecasting. Investments cannot be made without confidence that the company will have sufficient funds in the future. Cash flow forecasting helps the CEO time investments properly and ensures that growth can be achieved without cash crises. For example, when seeking financing from banks, cash flow forecasting also helps manage risks and plan when and how financing is needed for growth.

  1. Cash flow reveals financial problems early

Continuous cash flow monitoring allows a company to identify financial problems before they escalate. For instance, if a company consistently has negative cash flow, meaning more money is going out than coming in, it signals that something needs to change in the business. Cash flow reveals if the company is operating on borrowed money or struggling with its cash turnover. In such cases, management can make appropriate decisions before cash flow issues become critical.

Practical cash flow management

Cash flow forecasting is not just a tool for large companies; it is essential for small and medium-sized businesses as well. Even a simple cash flow forecast can provide valuable insights into a company’s financial situation and future needs. If you are seeking bank financing, regularly updating your cash flow forecast is crucial.

A cash flow forecast estimates the company’s income and expenses for the coming months or years. This helps management see when cash flow will be positive (surplus funds) and when it will be negative (additional funds needed). Based on these forecasts, large purchases or payments can be timed so that the company avoids a cash crisis.

The connection between cash flow and financing

Cash flow is also a critical factor when a company is seeking external financing. Banks and investors often assess a company’s cash flow in their decision-making process. Positive cash flow indicates the company’s liquidity and its ability to repay loans.

In what situations is a cash flow statement particularly useful?

A cash flow statement should be utilized in all business decisions. It is especially beneficial for a company when planning and making the following decisions:

  1. Recruitment (e.g., summer employees) – How much should be invested in the recruitment process itself? When will the first salaries be paid, and will the employees have ”paid for themselves” by that time?
  2. Larger investments – How will the company finance major investments? If loans or financing are sought, what additional costs will arise from them?
  3. Changing global circumstances (interest rates, inflation) – A familiar topic for all of us in recent years.
  4. Customer base and outlook – What is the customer churn rate, and at what pace must new customers be acquired to maintain positive business growth?
  5. Marketing – How much money is spent on marketing, and what return does it bring to the business?

How does Finaly utilize cash flow statements?

Finaly provides outsourced CFOs to companies, so we produce and utilize cash flow statements extensively in our clients’ operations. Typically, we update the cash flow statement monthly in collaboration with our clients. In addition to this, we provide a current review of the company’s financial position and suggest actions to improve the client company’s financial standing. It’s essential to interpret cash flow statements consistently and systematically (at least monthly), while also remembering that “no actions or changes are needed” is a decision in itself. This should also be documented to show the basis of decision-making and to provide the company’s management peace of mind. Professional and skilled financial leadership is crucial in all of these areas.

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