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Cash Flow Forecast and Management

Cash flow is the flow of money in and out of a business in a given time period. Cash flow forecasting is estimating the flow  of cash in the future. Managing cash flow is one of the most important aspects of financial management. Without the availability of cash from day-to-day, even the most successful businesses could fail. If a company cannot pay its bills, suppliers will refuse to deliver and staff will start looking for other jobs. Cash flow problems are the most common reason for business failure with 70% of businesses collapsing in the first year due to cash flow problems.

Businesses need to continually review their current and future cash position. In order to be prepared and to understand future cash needs, businesses construct a cash flow forecast. This sets out the expected flows of cash in and out of a business each month. In textbooks cash flows are normally shown for six months but they can be done for any period of time. Most firms want to look 12 months ahead, so the cash flow forecast is constantly updated.

Who Actually Needs to use a Cash Flow Forecast?
All businesses can benefit from using cash flow forecast but they are particular useful for business start-ups. A carefully planned cash flow forecast will help ensure that the business has enough finance to keep afloat during the early months. This is the most difficult period for a business as sales may be low. There will be little income but bills will need to still be paid.

Existing businesses also need to be aware of their cash position. In many cases there are seasonal factors that make cash hard to manage. A seaside hotel has, every year, to cope with winter months when there will almost certainly be negative cash flow – in other words, cash out will be higher than the cash coming in. A cash flow forecast will help to ensure that the business plans for future cash needs and can cope if unexpected events happen. If a business is growing, cash flow forecasts can be particularly useful. They enable the business to ensure that any growth is backed by sufficient funding.

Preparing a Cash Flow Forecast
To prepare a cash flow forecast businesses need to estimate all the money coming in and out of the business, month by month. The flows of money are then set onto a grid showing the cash movements in each month.

Benefits of a Cash Flow Forecast
A cash flow forecast will enable a business to do the following things:

  • Anticipate the timing and amounts of of any cash shortages. The business will be able to see it does not have enough cash and by how much. There is no such thing as negative money which means the business won’t be able to make payments be it to suppliers, workers or rent leaving the business in serious trouble. 
  • Following on from the first point, because the business anticipated this, they can use a source of finance to push there cash flow positive in the affected months where before it was negative.
  • Review the timing and amounts of receipts and payments.
  • Obtain loans (if the problems are long-term) or overdrafts (if the problems are short-term).
A cash flow also comes in handy when wanting to take out loans. A bank will always request a cash flow forecast. They do this in order to ensure that the business:
  • Has enough cash to enable it to survive.
  • Is able to pay the interest back on the loan.
  • Will be able to repay the full loan.
  • Is aware of the need for cash flow management.
There is no doubt that cash flow management is a vital ingredient in the success of any small or large business. For a new business, cash flow forecasting helps to answer key questions:
  • Is the venture viable?
  • How much capital is needed?
  • Which are the most dangerous months?
For an existing business the cash flow forecast identifies the amount and timing of any cash flow problems in the future. It is also useful for evaluating new orders of ventures.
Nevertheless, completing a cash flow forecast does not guarantee survival. Consideration needs to be given to its usefulness and limitations. It must be remembered that cash flow forecasts are based on estimates. These estimates are not just amounts but also timings. The firm must be aware that actual figures can differ wildly from estimates – especially for a new, inexperienced firm. When preparing cash flow forecasts, managers need to ask themselves ‘What if?’ A huge mistake is to only look at one forecast. It is far better to look at best case and worst case possibilities. Spreadsheets allow for easy manipulation of data, making it easy to see the impact of single and multiple changes to the forecast figures. This should help to reduce the risks. However, it does not guarantee success. The firm needs to be continually aware of the economic and market climate and its current cash position.
Key Terms
  • Best case – an optimistic estimate of the best possible outcome.
  • Cash flow forecast – estimating future monthly cash inflows and outflows, to find out the net cash flow.
  • Negative cash flow – when cash outflows are greater than cash inflows.
  • Overdraft – short-term borrowing from a bank; the business borrows only as much as it needs to cover its daily cash shortfall.
  • Worst case – a pessimistic estimate, assuming the worst possible outcome.

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