The ultimate cash flow forecasting guide for startups

Cash flow forecasting is a financial planning process that tracks the inflow and outflow of cash. Specifically for B2B leaders or SaaS CFOs, this means predicting the cash inflow from subscriptions and other revenue streams, and cash outflow in the form of operational expenses, capital investments, and other financial commitments, over a defined time period. 

The purpose of cash flow forecasting is to ensure adequate liquidity for business operations, identify any potential cash shortfalls, plan investments, and optimize cash management (where inflow exceeds the outflow). Cash flow forecasting is critical to understanding your cash runway in the short term and to inform your strategic planning for the longer term.    

This article is a comprehensive guide to cash flow forecasting, exploring the methods involved along with the benefits and challenges, and highlighting best practices that startup founders and CFOs can utilize for improving their cash flow forecasts. 

What is cash flow forecasting?

Before we get into cash flow forecasting, it is important to understand the concept of cash flow and its importance. In SaaS or any other business, cash flow defines the movement of cash in and out of a business, as well as the funds on hand. Understanding your company’s cash flow is critical to ensuring you have enough working capital to run your business effectively and making sound financial decisions. 

Cash inflow includes revenue from subscriptions or long-term contracts as well as revenue from services, including: 

• Recurring revenue from subscriptions
• One-time payments and setup fees
• Investment rounds and funding
• Asset sales, including equipment or property
• Interest earned from investments
• Customer upgrades or expansion revenue
• Advance payments and deposits

Cash outflows include all business and operating expenses:

• Operating expenses, such as employee salaries, premises’ rents, office utilities
• Software and technology costs
• Customer support costs
• Marketing and sales expenses
• Research and development expenses
• Equipment and asset purchases
• Professional service fees, such as legal, accounting
• Tax payments, including income tax, value-added tax, property tax
• Debt repayments and interest
• Insurance premiums

The formula for cash flow is simple:

For example, if a SaaS company has $475,000 in receivables and $325,000 in payables, per the above formula, the cash flow for that period is $150,000. 

Understanding cash flow helps SaaS leaders predict their business’ cash inflows and outflows over a specified period—that is, forecasting the business’ cash flow. It enables them to anticipate how much cash the business will have on hand at any given time. 

At times, cash flow forecasting is used interchangeably with revenue forecasting. While both terms may seem similar, revenue forecasting involves predicting monthly recurring revenue (MRR) and annual recurring revenue (ARR). On the other hand, cash flow forecasting focuses on predicting cash availability based on inflows and outflows. 

Types of cash flow forecasting methods

There are three main types of cash flow forecasting methods:

• Direct forecasting: This method starts at the account level and highlights cash positions and movements at specific future points in time. It relies on detailed data related to cash received from customers or payments to vendors (against invoices), employees (salaries), etc., and other operating-activities related expenses. 

• Indirect forecasting: This method highlights the cash needed for a business to scale up. Indirect forecasting draws from financial statements, such as net income from the P&L (income) statement and non-cash transactions/changes in the balance sheet, for its analysis.  The main difference between direct and indirect cash flow forecasting is that the direct method offers detailed, short-term cash flow visibility, while the indirect method provides a broader view of strategic planning and budgeting. 

• Rolling forecasts: A rolling forecast is a specific type of forecast that continually drops a completed period and adds another period extending by the same amount in the future. For example, a 12-month rolling forecast would begin as January through December for 2024, and when January 2024 actual results are finalized, that month would be dropped and replaced by January 2025. This method requires a deep understanding of how the business operates along with an objective analysis of internal and external factors that impact the business—both quantitative and qualitative—to create more informed, data-driven forecasts.

A comprehensive cash flow forecast must account for all sources of cash inflow, and also keep track of both regular and specific cash outflows.

How to create realistic forecasts with limited historical data

Cash flow forecasting might seem challenging for emerging startups or small SaaS businesses with limited historical data. In these situations, it is recommended to use conservative assumptions for the cash flow forecast. It might be useful to start with lower-end revenue projections, and account for longer sales cycles and higher customer acquisition costs. 

Scenario planning (best-case, worst-case, base-case) and what-if analysis are also important steps in the forecasting process as they enable CFOs and business leaders to assess the potential impact of different business decisions and external factors on cash flow and cash reserves, and be prepared for multiple potential future outcomes. 

Why is accurate cash flow forecasting so important for startups?

Accurate cash flow forecasting allows SaaS startups to plan for future financial scenarios and make strategic business decisions, by:

1. Identifying early warning signs: It flags any cash flow challenges, especially working capital and cash inflows, before they lead to serious cash runway problems.
2. Guiding strategic decisions: Forecasting helps leaders plan better for major purchases, technology investments, sales capacity, and product/market expansions and informs their long term strategic planning. 
3. Maintaining financial stability: Cash flow forecasting helps leaders maintain a steady cash flow for all business and operating expenses. 
4. Avoiding cash flow shortfalls: By understanding seasonal patterns and payment cycles between income and expenses, startups can maintain adequate cash reserves and strategize for extending their cash runway (as needed). 
5. Enhancing creditworthiness: Investors have more faith in businesses that manage their cash inflows and outflows efficiently. Further, low cost of capital helps attract more investment, reduces financing risks, and also increases the valuation of a SaaS business. 
6. ‍Enabling debt repayment: Effective cash flow management allows businesses to handle debt obligations without compromising operating needs.

Unique challenges in cash flow forecasting for startups 

Cash flow forecasting in SaaS startups has its fair share of challenges, including:

1. Using inaccurate data and ignoring historical data: Outdated or incomplete data could lead to varying or incorrect assumptions, impacting the accuracy of your forecast and misguiding financial budgeting and planning. Further, an emerging startup may not have enough historical data for creating detailed forecasts.
2. Dealing with limited cross-functional collaboration: When teams work in silos, they may not have access to the most relevant data, leading to inconsistent financial projections. 
3. Incurring high acquisition costs: A higher customer acquisition cost (CAC) can strain your cash flow and cash reserves if the revenue doesn’t offset expenses in the near term.
4. Facing customer churn and retention: Frequent customer churn reduces predictable revenue, which makes it challenging to forecast cash flow and scale consistently.
5. Managing delayed payments: Late clearances can lead to unpredictable cash inflows, impacting the assumptions in the forecast.
6. Creating complex forecasting models: It is important to remember that complexity does not always mean accuracy. A complex forecasting model is often unwieldy and difficult to understand, operate, maintain, and adjust—even by those who created it.

Top 10 best practices for improving your startup’s cash flow forecast 

Here are the top 10 best practices that SaaS startup leaders can follow to improve the accuracy of their cash flow forecasts. 

1. Track your cash inflows and outflows 

Understanding your company’s cash inflows and outflows is the foundation for creating a cash flow forecast. Varied factors, like evolving market demand, pricing strategies, capital expenditures, tech advancements, etc., influence cash flow.

It’s crucial to track and measure key SaaS metrics—including days sales outstanding, cash runway, days payable outstanding, operating cash flow margin, forecast variance, invoices overdue, credit losses, free cash flow, cash flow coverage ratio, cash conversion cycle— to be up-to-date on any cash inflows and outflows that can potentially impact your forecasts. 

2. Ensure data accuracy

Your forecast is only as good as the data that goes into it. It is necessary to ensure that your cash flow forecasts have detailed and accurate customer and business data. Also, it is important to review and ensure your revenue figures and expenses are up-to-date to reflect the latest figures. 

If you’re still using spreadsheets and manually inputting data, consider switching to a SaaS financial planning software that automatically gathers data from different sources and automates these processes. 

3. Track new bookings and contracts

New bookings and contracts in SaaS mean potential cash inflows. However, this needs to be appropriately tracked. Monitoring these signed agreements, including when and how much they’ll contribute to cash flow, gives leaders a more accurate picture of anticipated cash. Similarly, you also need to account for delays that can affect the timing of the cash inflows. 

For example, a client signing a $200,000 annual contract might only translate to actual cash at the time of implementation. Without careful contract tracking, you might overestimate available cash and make premature spending decisions.

4. Account for churn rates and renewals

For early-stage SaaS companies, cash inflow can be unpredictable, especially when customer acquisition takes time or churn rates are high. This variability can make it tough to cover fixed expenses consistently, leading to cash flow strain.

Even with additional working capital from funding or debt, many SaaS startups experience negative operating cash flow. If the business relies on its cash reserves to cover operational costs, it's burning cash. In all these cases, a cash flow forecast becomes all the more essential for accounting for customer churn and sustaining business growth.

5. Cash inflow does not equate to revenue 

Revenue is the income a company earns by providing its services, like a subscription fee paid by users. Sometimes, revenue can be deferred, which means it is recorded as income over a defined period rather than immediately. 

On the other hand, cash inflow includes any cash received, such as sale of services/products (revenue), investments, and financing. When revenue is mistaken for cash inflow, it skews forecasts and affects budgets and spending decisions. 

6. Consider different pricing models

Your pricing model plays a huge role in cash flow forecasting. Annual subscriptions bring in cash upfront but spread out revenue recognition, while monthly subscriptions result in regular cash inflow. Further, making adjustments to your pricing strategy can also impact cash flow forecasts. For instance, if you shift from flat-rate pricing to usage-based pricing, it can make a significant difference to your cash inflow.

7. Break down expenses 

A single overlooked expense can derail your entire forecast. By breaking down all expenses, you can identify patterns in your cash usage and better predict future cash needs. Separate fixed costs (like rent) from variable costs (like marketing spend) in your budget. This makes it easier to predict cash outflows more accurately. 

8. Create your first forecast after year one

A SaaS startup’s first year has no historical data. Without this, your forecasts will be based on industry averages that might not even apply to your specific business model or market segment. Use the initial data to identify trends in sales, expenses, and seasonal fluctuations, and combine those with your first year’s business and operating data to create a more informed cash flow forecast for the short term. 

9. Conduct scenario planning

Your actual cash flow may deviate from projections due to market changes, economic downturns, or other exigent situations. In such cases, scenario planning helps identify and mitigate potential risks and uncover better opportunities for growth.

10. Review and update forecasts regularly

SaaS startups operate in an environment that changes rapidly. Reviewing your forecasts monthly or quarterly helps you catch any variances early and adjust the assumptions accordingly. It also makes sure your forecast stays relevant and aligned with real-time business conditions.

Optimize your cash flow and improve your cash flow forecasting with Drivetrain

For early-stage startups, cash inflow can be unpredictable due to slower customer acquisition or high churn. This, in turn, impacts fixed expenses. These startups are also under pressure to grow rapidly, resulting in marketing, sales, product development, and hiring costs. In this situation, accurate cash flow forecasts are essential for managing operating expenses and business budget, as well as sustaining growth.

Many startups continue to rely on spreadsheets to create forecasts. Not only do these increase the probability of errors due to the manual processes involved, but the unwieldiness of the spreadsheets makes it difficult to update the assumptions in the forecasting model when needed. Implementing a cash flow forecasting software can help automate the data consolidation and validation process necessary to get started. 

Also, using a strategic finance software, like Drivetrain, becomes a gamechanger as it integrates seamlessly with your current systems, consolidates both historical data and actuals for expenses, sales, payables, and receivables, and allows you to slice and dice that data however you want to create more informed cash flow forecasts for your SaaS business. 

Drivetrain can transform the complex task of cash flow forecasting into a streamlined process, allowing users to run calculations using plain-English formulas and model different scenarios to analyze the best possible outcomes based on changing variables and market trends. 

Additionally, this user-friendly, spreadsheet-inspired platform reduces manual errors and generates data-backed insights in real time, enabling CFOs and finance teams to focus on strategic decisions that drive growth.

Explore how Drivetrain can help you track, predict, and manage your cash flow more efficiently.