Why it’s crucial for your business to implement regular cashflow forecasting
Cash flow forecasting is an art of estimating cash inflows and outflows in a business over a specified period of time – usually one year. Based on the cash flow forecast, the business is able to establish if it should borrow, how much to borrow, plus when and how the loan should be repaid.
This is the cash flow budget, also referred to as a cash flow projection. A business can predict the bank balance at the end of the specified duration.
An example of a three-month cash flow forecast for a firm is as shown in the table below:
|Beginning of the month||250||200||150|
|End of the month||200||150||50|
Objectives of the Cash Flow Forecast
A company uses the cash flow forecast to;
- Point out deficits in cash balances. If a forecast returns a negative value a business has to put in place measures to counter shortfalls. A good contingency plan would be to ensure there is sufficient bank overdraft provision.
- Analyse the business performance against financial objectives set in the business plan. Using a cash flow budget will tell whether objectives are met or not and to what extent.
- Determine if the firm’s trading performance turns into cash. The trading performance is not just measured by just the amount indicated at the end. Measuring your daily or weekly trading performance is a key tool in achieving consistent long-term gains. This includes monitoring revenues, costs and profits.
Importance of Cashflow Forecasting
If a business, for whatever reason, runs into debt and is unable to acquire finance, it will become insolvent. So, that means that cash is king and cash flow is the bloodstream that keeps any business running, especially small and medium enterprises (SMEs) – and start-ups.
Their survival is 100% dependent on the management’s cash flow prediction. The key reasons cash flow forecasting is necessary to include:
- Debt repayment assessment- makes sure the business can be able to pay its employees and suppliers. The suppliers make sure the business is not out of supplies while the employees make sure the business is actually running.
- Spot potential shortfalls- If a business can predict future deficiencies from the onset, it can be able to put in place measures to mitigate shortfalls. Early warning signs will help the business decide on what course to take.
- For stakeholders and other external entities like banks may require regular cash flow forecasting reports. Stakeholders want to know where their investment is heading. If you have a loan at the bank, they want to assess the likelihood of the business not making repayments at regular intervals
- A general financial planning discipline – having regular cash flow forecast is a part of the important management process that should be carried out regardless of financial certainty.
- Identify problems in customer payments. This is very important especially for businesses that do not deal with cash and credit cards. A business that does not have a point of sale and heavily operates of credit basis need to track how often and promptly the customers make payments.
- Assess liquidity and Solvency- A business can tell the flow of the cash equivalent. Therefore, the liquidity and solvency position as well can be maintained certainty and timing of cash generation can be estimated
- Evaluation of cash flows in future – are current operating activities sufficient for a stable future? Do they meet various payments e.g. dividends, taxes, debts and expenses
- Information users of accounting in different ways
- Assess a business’s ability to pay its obligations promptly
ii.Analysis and interpretation of various trends for future course of action
The downside to Using Cashflow Forecasting
For purposes of strategic goals and removing uncertainty, businesses rely on cash flow forecasts to make long-term plans. The technique has been applied globally and for a very long period of time as a key to financial independence.
It has basically become an integral part in the financial management process. Is there a flip side of cash flow forecasting? Well, obviously the approach is a great deal important but it also has a few cons.
Below is a list of some limitations of cash flow forecast
Unforeseen factors- the forecast can be skewed due to external factors experienced by the firm. Increased competition or changes in government policies can change expected cash inflows and outflows.
This means the initial data has a big variation gap than expected. Unforeseen factors have to be accounted for and the end value will not remain the same.
Inadequate Information- drafting the forecast means relying on the limited information available. Accountants strive to gather all information to fill in the estimates and calculate the expected figures. However, since the figures are not accurate the results might be wrong.
Unstable business environment- In the business environment, everything is volatile. What was of service yesterday may be useless today. To manage the stable nature of the business environment, firms must learn to adjust their expectations as the environment changes whether it is in their favour or against them.
Best estimates– cash flow forecasting is dependent on a certain degree of probability regardless of how valuable information is. There is no 100% guaranteed accuracy even in the short run. As the forecast period increases, so does the degree of inaccuracy.
The difference between a business that thrives and the one that fails is mostly cash management. Having little cash may lead to being unable to operate the business at normal levels.
Therefore, businesses may be forced to pass on profitable ventures or resort to taking out loans to avoid liquidity issues. In most cases, the business may have to shut down altogether.
To avoid all these issues businesses, rely on cash flow forecasts to give them a sense of what to expect and give them a chance to better prepare for the future.
No one time the cash flow forecast will give precise figures and be spot on and that is why it is termed as a prediction. Therefore, conducting regular cash flow forecasts on your business is the best approach in preparing for future financial needs.