Tweet

Cash Flow Forecasting

Guest post by: Arthur Rothberg

Article Overview: A cash flow forecast, or cash flow projection, is a key element of financial strategy that supports near-term financial processes, overall capital structure and asset valuations. Included in this article is a look at the eight ways cash flow forecasting helps a company assert control of its financial situation. Both direct and indirect methods of cash flow forecasting are addressed with the former including the receipts and disbursements method, while indirect methods reviewed include adjusted net income, pro-forma balance sheet and accrual reversal.

Cash Flow Forecasting

It is a CFO's responsibility to make sure the company can pay its obligations, achieve its business goals and fund its growth objectives. This calls for planning, analysis and a solid cash flow forecast.

A cash flow forecast, or cash flow projection, forms the basis of a firm's near-term financial processes as well as its long-term stability. Forecasting incoming cash enables a business to plan and manage cash outflows and maintain solvency. In addition, cash flow projections underlie a firm's capital structure, asset valuations and strategic planning processes.

Cash flow budgeting enables an organization to assert control of its financial situation in various ways, including:

• Ensure adequate cash is available to make payroll, pay suppliers and cover operating expenses.
• Time capital expenditures and investments based on projected revenues.
• Grow strategically through expansion and/or acquisitions.
• Anticipate and address potential deficits proactively.
• Invest surplus capital for maximum return.
• Balance pricing, inventory turns and market share growth.
• Monitor receivables closely and pursue slow-pays as appropriate.
• Monitor inventories and balance them against sales and bookings.

Cash flow is essentially the change in a company's treasury position from one period to the next. Typically, it is projected for at least a 13-week (one-quarter) period. Cash generally includes bank balances and short-term investments. A cash flow projection does not include non-cash items such as depreciation and amortization since they do not involve cash outlays.

A spreadsheet can be used to show cash input from all sources and cash output for the period. Budgeting software can simplify the process of setting up a cash flow forecast and systematic cash flow analysis.

It is important that projections about the quantity and timing of forecast inputs be as accurate as possible. Regularly recurring expenses, such as payroll, benefits, insurance, rent, utilities and loan repayments are relatively fixed. Expenses such as advertising, travel and entertainment (T&E), and manufacturing inputs often fluctuate from period to period. Disbursements for fixed asset purchases, maintenance costs and professional services can vary widely. Use previous experience and realistic estimates when projecting these items.

Methods of cash flow forecasting

With direct forecasting, the receipts and disbursements (R&D) method is based on anticipated cash receipts and disbursements. Receipts include accounts receivable from sales, as well as asset disposals, and other miscellaneous proceeds. Disbursements include rent and/or lease payments, payroll, accounts payable to vendors and suppliers, dividends and debt servicing. The basic steps involved in developing a direct-method cash flow projection include the following:

• Determine projected revenue based on monthly sales or billings.
• Estimate timing and amount of receipts (accounts receivable or AR).
• Identify any additional expected cash inflows, such as loans, refunds, and deposits.
• Compile all expenses and other payables.
• Estimate payment dates for disbursements (accounts payable or AP).
• Calculate the amounts in a cash disbursements forecast.

In addition to the direct method, there are several indirect methods of forecasting cash flow that rely on projected income statements and balance sheets as a basis for projecting cash flow.

Adjusted net income (ANI)

This method of cash flow forecasting is based on operating income. Using either EBIT or EBITDA as a metric, balance sheet accounts (i.e., AR, AP and inventories) are used to forecast cash flow.

Pro-forma balance sheet (PBS)

The PBS method uses projected sales based on a specified production schedule minus expenses for the period to arrive at a forecasted profit figure.

Accrual reversal method (ARM)

ARM is a combination of the (direct) R&D and the (indirect) ANI methods. Using statistical distributions, the ARM method can be used to forecast cash flow accurately for a year or more.

These indirect methods of cash flow forecasting are generally used for medium or long-term forecasting horizons.

Red flags

During the quarter, try to adhere to the planned net cash flow position. It is important to pinpoint any significant variances between cash flow projections and actual financial results. Stay on top of metrics such as days sales outstanding (DSOs), days payments outstanding (DPOs) and inventory turns, as these can be early indicators of potential cash flow problems. Take steps to address these key activity ratios before they become problematic. Actions to consider include stepping up collection efforts, holding invoice payments until their due date, re-negotiating contract terms with suppliers and vendors, and/or taking pricing actions to accelerate sales or reduce inventory.

It is not unusual for cash flow to fluctuate due to factors such as seasonality, maintenance shutdowns and input cost variations. If a shortfall looms, it may be necessary to draw on a line of credit, ramp up sales efforts, sell non-core assets, raise equity or obtain additional bank financing.

While it can be tempting to relax credit policies in an effort to boost cash flow, it is important to ensure that credit policies remain balanced. That is, credit policies should not be so restrictive that they result in losing sales and missing the full value from potential long-term customers. And conversely, credit policies should not be so lax that inventory is being sent to customers who are not paying their bills in a timely manner.

A living document

A sound, realistic cash flow projection enables a business to make investments with confidence, plan capital expenditures strategically and set reasonable goals. A cash flow forecast should be thought of as a living document and updated regularly to reflect new information, such as macro-economic factors, micro-economic trends or new business activities that could impact the business, its clients or its cash flow. Proactive cash flow management requires a systematic approach that enables management to understand its cash cycle and to manage cash outflows, make well-timed expansion and hiring decisions, and, above all, anticipate potential cash flow gaps or other associated problems.

Los Angeles CEOs and CFOs who do not have internal expertise, resources or capacity to set up a cash flow projection and review mechanisms often turn to an outsource provider of CFO services to get started. It then becomes a routine matter to run the cash flow reports, analyze the results and take corrective actions.

Related Articles
  CASH FLOW - You're Forgiven for Misunderstanding the Term!
  Internet Cash Flow-Finding A Cash Flow Business
  Writing Tip: Use a forecasting subject line
  Keep cash flow to an optimum
  Stressed out about sales forecasting?
  Working Capital Management: How to keep your Cash Flow Strong
  Cash Flow Forecasts
  Positive Cash Flow leads to success
  Working Capital Business Financing Sources
  Creating cash flow forecasts
  Financial Cash Flow Management: Tips to Improve the Cash Flow of Organization
  5 Smart Simple Canadian Working Capital Cash Flow Financing Loan Techniques !
  Working Capital and Business Lending in Canada Without the Voodoo!
  Understanding Business Cash Flow
  Three Sure Signs That Your Business Will Run Out of Cash – And What To Do About It
  Cash is King
  Canadian Business Loans – is my Cash Flow really free? And how Free is It!
  Cash Flow for Real Estate Investors
  Inigo Montoya’s Guide to Cash Flow Financing . The Business Working Capital Loan demystified !
  Small Business Planning - Or Not!

Article Tags: accrual reversal, adjusted net income, cash flow, cash flow forecast, cash flow projection, credit policies, days payments outstanding, days sales outstanding, financial strategy, inventory turns, pro forma balance sheet



Related Forum Posts
Improving Cash Flow - How do I improving Cash Flow? What the best way to improve it to another 100% growth YOY? Has anyone does this or achieved this using online marketing? Thanks, Roberts
Re: Improving Cash Flow - Thanks for your information. guide on how to avoid the problems of over trading. <-- Where is this guide? Any URL? guide on debt factoring and invoice discounting: the basics. <-- Where is this guide? Any URL? I just want to learn more about this. I am also looking for a good article on: What exactly is Cash Flow? Ways to improve cash flow at individual level and organizational level? I think it is a problem of thinking and mind sets problem. If we can change the way of spending, we can have more Cash. Robert
Re: Apologizing for my absence, and an update... - Apology accepted and thank once again for reviewing my copy of [i:3v8lr26m]Offline Cash Magic[/i:3v8lr26m] report
Best incentive to offer employees - What's the best incentive to offer employees? Is it more health benefits? More vacation? Health club memberships? Paying for training? Cash / non-cash bonuses & rewards? I'm preparing a new package for my company and would love to get your thoughts! Thank you in advance!
Re: Cash up front ... or Royalties? - This is a very interesting question GT. I also chose Cash up front, I like being careful, especially if I don't know what is the investment. Some business are to risky and you may never get the royalties. The best deal will be get a one time payment PLUS royalties, this is how you do business.


Share this article with your friends. Fund someone's dream.

Leave a comment below or share on the left and you'll help support entrepreneurs in Africa through our partnership with Kiva. Over $50,000 raised and counting - Please keep sharing! Learn more.

Newsletter

Get advice & tips from famous business
owners, new articles by entrepreneur
experts, my latest website updates, &
special sneak peaks at what's to come!

Name:
Email:

Popular Articles

Intro to Search Engine Optimization

How to Write Your Articles for Better SEO

How do I finance a franchise?

Suggestions

Email us your ideas on how to make our
website more valuable! Thank you Sharon
from Toronto Salsa Lessons / Classes for
your suggestions to make the newsletter
look like the website and profile younger
entrepreneurs like Jennifer Lopez.