What is a Cash Flow Forecast?

The Cash Flow Forecast is the most important aspect of accounts preparation, be it Management Accounts & Cash Flow Forecast the accounts prepared by a company for internal management use, or accounts prepared for a lender, such as a bank to evaluate how you will be able to repay the funding. Where the The Balance Sheet and the The Profit & Loss Account are primarily prepared for your actual year end figures for submission to Companies House, the Cash Flow Forecast needs to be, some say, pessimistic as to your sales figure and expenses. One problem we all face at some stage is preparation of a Cash Flow Forecast for the bank manager. It is almost impossible to submit honest figures when you use pessimistic figures when you look at the finished result you say to yourself I would not give anyone a loan if I saw these figures. However, I suggest you do use pessimistic figures and inform the lender that the figures are pessimistic, and as such, are very achievable. Returning to your lender 6 12 months after arranging a loan or overdraft facility, and asking for more funding because your original figures were way out, will not impress the lender. Cash Flow Forecast Example The example below evenly spreads out all costs. In reality, utilities, lease, etc are paid quarterly, some in advance, others in arrear. It is advisable to enter the proper amount in the month that the payment is due to ensure you are aware of the highs and lows of your cash requirements. However, the example below is a good tool for setting out your budget. In most cases, a business should forecast for a 12 month period. However, we have cut our example down to 3 monthsjust so that you get the idea. In addition, we have simplified the content (listings on the left-hand-side) to make it easier to follow and understand. All figures in Open INCOME Jan Feb March 3,000 3,500 3,000 3,500 100 10 110 150 300 450 1000 100 10 110 200 350 550 1000

Sales 3,000 Capital In 10,000 TOTAL INCOME 10,000 3,000 FINANCES / ASSETS Loan Repayments 100 Interest Paid 10 TOTAL FINANCES / ASSETS 110 DIRECT COSTS Materials 150 Direct Labour 300 TOTAL DIRECT COSTS 450 EXPENSES Salary 1000

Office Rent Telephone Utilities Insurance TOTAL EXPENSES OPENING BALANCE* TOTAL INCOME TOTAL OUTGOINGS NET CASH FLOW* ENDING BALANCE*

100

100 100

100 100

100 1,200 1,200 1,200 10,000 11,240 12,480 10,000 3,000 3,000 3,500 1,760 1,760 1,860 10,000 1,240 1,240 1,640 10,000 11,240 12,480 14,120

* Negative figures would be denoted by ( ) i.e. 500 = (500) The last five rows of the forecast are: Opening Balance This figure is the ending balance of the previous month Total Income This is the total income figure for the month (highlighted in blue). Total Outgoings This is the combined total of the outgoings (highlighted in yellow). In this case, we have three outgoing costs for each month (finance, direct costs and expenses). Net Cash Flow This is the difference between the total income and the total outgoings. It is worked out by subtracting the total outgoings from the total income. Ending Balance This is the ending balance at the end of the month. This figure is obtained by adding (or subtracting if it is a negative net cash flow) the net cash flow to the opening balance of the month. How Credit Will Affect the Cash Flow Forecast If you offered, say, 1 months credit to your customers, you would enter the sales figure in the month that you would be paid. For example, if a customer makes a purchase of 200 in January with one months credit you would include the figure in the February sales. Cash Forecasting Methods, Homework Help Two most commonly used methods of short-term cash forecasting are: 1. The receipt and disbursements method 2. The adjusted net income method. The receipts and disbursements method is generally employed to forecast for limited periods, such as a wet or a month. The adjusted net income method, on the other hand, is preferred for longer durations raging between a few months to a year. Both methods have their pros and cons. The cash flows can be compared with budgeted income and expense items if the receipts and disbursements approach is followed. On the other hand, the adjusted income

approach is appropriate in showing a companys working capital and future financing needs. Receipts and disbursement method Cash flows in and out in most companies on a continuous basis. The prime aim of receipts and disbursements forecasts is to summaries these floes during a predetermined period. In cash of those companies where each item of income and expense involves flow of cash, this method is favored to keep a close control over cash. Three broad sources of cash inflows can be identified: (i) operating, (ii) non-operating, and (iii) financial. Cash sales and collections from customers form the most important part of the operating cash inflows. The next stop in the preparation of a cash budget is the estimate of cash outflows. Cash outflows include: (i) operating outflows: cash purchases, payments of payables, advances to suppliers,, wages and salaries and other operating expenses, (ii) capital expenditures, (iii) contractual payments: repayment of loan and interest and tax payments; and (iv) discretionary payments: ordinary and preference dividend. In case of credit purchases, a time lag will exist for cash payments. This will depend on the credit terms offered by the suppliers. Once the forecasts for cash receipts and payments have been developed, they can be combined to obtain the net cash inflow or outflow for each month. The net balance for each month would indicate whether the firm has excess cash or deficit. The peak cash requirements would also be indicated. If the firm has a policy of maintaining some minimum cash balance, arrangements must be made to maintain this minimum balance in periods of deficit. The cash deficit can be net by borrowing from banks. Alternatively, the firm can delay its capital expenditures or payments to creditors or postpone payment of dividends. One of the significant advantages of cash budget is to determine the net cash inflow or outflow so that the firm is enabled to arrange finances. However, the firms decision for appropriate sources of financing should depend upon factors such as cost and risk. Cash budget helps a firm to manage its cash position. It also helps to utilize ideal funds in better ways. On the basis of cash budget, the firm can decide to invest surplus cash in marketable securities and earn profits. Adjusted net income method This method of cash forecasting involves the tracing of working capital flows. It is sometimes called the sources and uses approach. Two objectives of the adjusted net income approach are: (i) to project the companys need for cash at a future date and (ii) to shoe whether the company can generate the required funds internally, and if not, how much will have to be borrowed or raised in the capital market. As regards the form and content of the adjusted net income forecast, it resembles the cash flow statement discussed previously. It is, in fact, a projected cash flows statement based on proforma financial statements.