Cash flow modeling is a powerful process that will help you understand not just the health of your business based on your current cash flow, but also its strengths and weaknesses, and its worth as measured by calculating the present value of your future cash flow. This is how lenders and buyers evaluate businesses, so it’s very useful information for you to have.

“Cash flow modeling is critical for two reasons,” says Yaniv Konchitchki, accounting professor at the University of California, Berkeley’s Haas School of Business. “First, it helps you understand your business. It will allow you to identify the drivers that generate your cash flow. You can see where you are making money and where you are losing money.

“Second,” he says, “it helps you determine the value of your business, which is based on your cash flows in the future. If you want to raise money or sell your company, the more cash flow you can generate, the more money you will get.”

This forward-looking measurement is known as discounted cash flow. It takes your projected future cash flows from all sources and converts them to present value. Discounted cash flow is key, says Konchitchki, because it tells you the value of your company.

Why is future cash flow discounted? “Money in the future is worth less than the same amount of money today,” Konchitchki explains. “That’s because the money you have today can be invested, and the return will enable you to exceed what you receive in the future.”

Another important calculation is your company’s free cash flow. “This is how much you generate out of your operations, minus how much you invest in capital expenditure,” says Konchitchki. “To sustain operations, you need to keep investing.”

Cash flow modeling enables you to determine a variety of additional key measures—cost of capital, cost of debt, discounting rate, cash flows from operating, investing and financing activities, capital expenditures, sensitivity analyses, valuation assumptions and methodology and more—that may be important, depending on the nature of your business and how it is capitalized. “Each measure tells you something different,” says Konchitchki.

A number of templates for cash flow modeling are available online (see sample resources, below), and they are no more difficult to work with than an Excel spreadsheet. Still, the quality of the information you generate is based on the accuracy of the information you put in. That, in turn, is based on your understanding of how to make assumptions—for example, about the growth of your company.

Konchitchki urges caution. “These templates can give you a very rough idea, but you need to have the right knowledge,” he says. “For example, the discounting is difficult if you don’t know how to calculate it properly, and you can end up way off. You’re better off asking for help from your bank or someone else with specialized knowledge. These calculations are critical to your business, and you want to get them right.”