Benefits of a Cash Flow Forecast
A cash flow forecast is an essential tool in helping a business prepare for the future. As the old saying goes, ‘cash is king’, therefore ensuring that your business has sufficient cash flow will enable it to continue operating effectively in the future.
So what exactly is a cash flow forecast?
The cash flow forecast aims to predict the net cash flows of the business over a future period, by estimating what the cash inflows (receipts) and cash outflows (payments) of the bank account will be. This provides an estimate of the bank balance at the end of a given period, typically monthly, but it can be as frequently as weekly or daily.
Although there is a certain amount of estimation in predicting future cash flows, a business should already have a good idea of how much it pays for its regular expenses such as rent, utilities, insurance, etc. so these outflows should be fairly accurate. Other outflows such as wages and materials/purchases tend to be directly correlated to future sales volumes.
Future sales can be forecasted by analysing past sales trends, periods of seasonality, as well as looking at current data and future assumptions of both the business and marketplace. The more accurately you can predict your future sales the more valuable the information is for others making decisions within your business.
What are the advantages of a cash flow forecast?
- Primarily, to identify potential shortfalls in cash balances. A negative cash balance can be detrimental to a business; if there is insufficient cash to pay bills it could lead to the business becoming insolvent. The cash flow forecast can identify these periods of low/negative cash flow which can prompt management to ensure that a sufficient bank overdraft facility is in place.
- The cash flow forecast ensures that the business can afford to pay suppliers and employees. Suppliers that don’t get paid will soon stop supplying the business, whilst the business could be brought to a standstill if employees don’t get paid.
- Financial planning – the cash flow forecast is an important tool for the management of the business to implement plans and can assist in preparing business budgets and making financial decisions for the future.
- The cash flow forecast encourages the business to analyse how quickly its credit customers are paying their debts. This will identify problems with persistent late payers and potential bad debts, which could affect future cash flow.
- External stakeholders such as banks may require a cash flow forecast if the business has a bank loan. The bank will want to look at the cash flow forecast at regular intervals to ensure the business can meet monthly repayments.
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