Chapter 30 - Forecasting and Managing Cashflows
Lesson Objective: To understand the basics of a cash flow forecast
Cash Flow is the sum of cash inflows minus (-) the sum of cash outflows. It is the net amount of cash and cash-equivalents being transferred into and out of a business:
The question repeats itself: can a profitable business run out of cash?
It is a common problem:
If the business does not plan its receipts (inflows) and payments (outflows) carefully it can become insolvent and therefore be taken to liquidation.
- Inflows: payments from customers, or any other financing activity (sale of assets, loans, etc.);
- Outflows: any payments in cash made by the business (to suppliers, banks, etc.).
Therefore...
Cash is specially important for liquidity and survival (short-term debts).
Profit does not have the same sense of urgency as cash and can be made in the medium to long-term.
With that in mind, it is possible to understand that Cash Flow is specially important to small businesses as they experience particular challenges:
Usually shorter credit terms offered by suppliers when compared to large businesses;
Terms and conditions for debt finance (e.g. loans) are usually stricter and difficult;
Unlike large businesses (with access to various sources of finance) any problems caused by cash flow may cost the small business survival.
To further understand Cash Flow Forecast we need to clarify the most common sources of inflows and outflows to businesses - some of which are easy to forecast and other which are unpredictable:
Inflows:
- Capital Injection (Investors): Easy to forecast and accurate;
- Bank Loans: Easy to forecast and accurate;
- Customer Cash Sales (Sales Forecasts): Difficult to forecast (although possible for businesses with historical data);
- Trade Receivables: The same logic as customer cash sales.
Outflows:
- Lease/Loan Payments: Easy and accurate to forecast;
- Fixed Costs: Rent, insurance, etc. are easy and can be accurately forecasted;
- Variable Costs: Difficult to forecast as it depends on sales forecast;
- Labor Costs: Can be easy or hard, depending on the payment system (salary, piece-rate, etc.).
The structure of a Cash Flow Forecast is simple:
It is divided in to three basic sections:
Cash Inflows
Cash Outflows
Net Cash Flows (Opening and Closing Balances)
Net Cash Flow is the difference between inflows and outflows;
Opening Cash Balance is the cash carried on from last month's...
Closing Cash Balance, which is the cash held by the business at the end of the month/period and will become next month's Opening Cash Balance.
Activity 30.1
Cash Flow Forecast is Useful!
- Aids on predicting future financial difficulties which helps with planning for additional finance (debt or equity);
- Helps businesses visualize and plan the decrease of outflows (e.g. delay the purchase of an asset);
- Cash Flow Forecast is a necessary piece of information in any business proposal - for investors.
Although useful, the Cash Flow Forecast is not perfect:
Any mistakes on forecasting revenues or costs will make the entire analysis inaccurate. For example:
- Unexpected cost increases will lead to wrong forecasts (e.g. increased gas prices);
- Wrong assumptions regarding sales will jeopardize the analysis (e.g. poor market research).
Chapter 30 - Forecasting and Managing Cashflows
To-Do-List: Activity 30.2
Commentaires