Preparing a Cash Flow Forecast

Preparing a Cash Flow Forecast

Understanding the Concept

• A cash flow forecast is a document that provides estimates of the cash going in and out of a business within a specified period.
• The purpose of the cash flow forecast is to help businesses anticipate future cash positions. This ensures sufficient liquid assets to meet liabilities and obligations when they fall due.
• It comprises three key sections: cash inflows, cash outflows, and net cash flow.

Cash Inflows

• Cash inflows are the estimated income that a business expects to receive within the period covered by the forecast.
• They can come from various sources, including sales of goods/services, rental income, loans received, and interest on investments.
• Sales income can be forecast based on the business’s past performance, market research, and economic indicators.

Cash Outflows

• Cash outflows are the estimated expenditures a business expects to make within the forecast period.
• Examples of cash outflows include rent, wages, utility bills, raw material purchases, advertising costs, loan repayments, and tax payments.
• Like inflows, outflows can be forecast using past data, contracts, and industry norms.

Net Cash Flow

• The net cash flow is calculated by subtracting the cash outflows from the cash inflows.
• It indicates whether the business is projected to have more inflows (positive cash flow) or outflows (negative cash flow) during a set period.
• Ideally, businesses want to have a positive cash flow to secure their financial stability and growth.

Preparing a Cash Flow Forecast

• To prepare a cash flow forecast, firstly, identify and list down the potential cash inflows and outflows.
• Then, estimate the expected amount for each item for the forecast period, typically done monthly.
• Calculate the net cash flow and the closing cash balance for each period.
• The closing cash balance for one month becomes the opening cash balance for the next month.

Benefits of a Cash Flow Forecast

• It enables businesses to anticipate potential cash shortages and take proactive measures, such as arranging for extra funding.
• It supports improved decision-making regarding future investments, expenditures, and credit management.
• It assists in negotiations with banks or investors since it provides a detailed financial picture of the business’ future.

Limitations of a Cash Flow Forecast

• The accuracy of a cash flow forecast depends heavily on the quality and reliability of the data used.
• If the actual sales and expenses differ significantly from the forecast, the cash flow forecast may mislead the business’s cash position.
• It is static and doesn’t account for sudden changes in the business environment like unexpected expenses or changes in market demands.