Cash Flow Forecasting for Business Success

Posted on Jan 5, 2025 in Economy

Forecasting Cash Flow

Cash Flow Definition

  • Cash flow: The sum of cash payments to a business (inflows) less the sum of cash payments (outflows).
  • Liquidation: When a firm ceases trading and its assets are sold for cash to pay suppliers and other creditors.
  • Insolvent: When a business cannot meet its short-term debts.

Importance of Cash Flow Planning for Entrepreneurs

Cash flow planning is vital for entrepreneurs because:

  • New business start-ups are often offered much less time to pay suppliers than larger, well-established firms.
  • Banks and other lenders may not believe the promises of new business owners as they have no trading records.
  • Finance is often very tight at start-up.

Cash and Profit – What’s the Difference?

  • Cash inflows: Payments in cash received by a business, such as those from customers (debtors) or from the bank.
  • Cash outflows: Payments in cash made by a business, such as those to suppliers and workers.

Forecasting Cash Inflows

Examples of cash inflows and how they might be forecast:

  • Owner’s own capital injection: Easy to forecast as this is under the manager’s direct control.
  • Bank loan payments: These will be easy to forecast if they have been agreed with the bank in advance.
  • Customers’ cash purchases: Difficult to forecast as they depend on sales.
  • Debtors’ payments: Difficult to forecast as these depend on two unknowns.

Forecasting Cash Outflows

Some examples of cash outflows and how they might be forecast:

  • Lease payments for premises.
  • Annual rate payment.
  • Electricity, gas, water, and telephone bills.
  • Labor-cost payments.
  • Variable-cost payments.

Structure of Cash Flow Forecasts

Three basic sections:

  1. Cash inflows: Record cash payment to the business.
  2. Cash outflows: This section records cash payments by the business.
  3. Net monthly cash flow, opening, and closing balance.

Cash Flow Forecasting – Limitations

  • Mistakes could be made in preparing the revenue and cost forecasts, or they may be drawn up by inexperienced entrepreneurs or staff.
  • Unexpected cost increases can lead to major inaccuracies in forecasts.
  • Wrong assumptions can be made in estimating the sales of the business.

Causes of Cash Flow Problems

  • Lack of planning.
  • Poor credit control.
  • Allowing customers too long to pay debts.
  • Expanding too rapidly.
  • Unexpected events.

Increasing Cash Inflows

  • Overdraft: Flexible loans on which a business agrees limits with the bank.
    • Interest rates can be high.
    • Can cause insolvency.
  • Short-term loan: A fixed amount can be borrowed for an agreed length of time.
    • Interest costs have to be paid.
    • The loan must be paid by the due date.
  • Sale of assets: Cash can be obtained by selling assets, which will boost cash inflows.
    • Selling assets quickly can result in a low price.
    • Assets could be needed in the future.
  • Sale and leaseback: Assets can be sold to a finance company but can be leased back from the new owner.
    • Leasing costs add to annual overheads.
    • Loss of potential profit if the asset rises in price.
  • Reduce credit terms to customers: Cash flow can be brought forward by reducing credit terms.
    • Customers may purchase products from other firms that offer extended credit terms.
  • Debt factoring: These companies can buy the customers’ bills from a business and offer immediate cash – reduces risks of bad debts too.
    • Only about 90-95% of the debt will now be paid.
    • If the customer has the debt collected by the finance company, it might mean the business is in trouble.

Reducing Cash Outflows

  • Delay payments to suppliers (creditors): Cash outflows will fall in the short term if bills are paid after.
    • Suppliers may reduce any discount offered with the purchase.
    • Suppliers can either demand cash on delivery or refuse to supply at all if they believe the risk of not being paid is too great.
  • Delay spending on capital equipment: By not buying equipment.
    • The efficiency of the business might fall if outdated and inefficient equipment is not replaced.
    • Expansion becomes very difficult.
  • Use leasing, not outright purchase of capital equipment: The leasing company owns the asset, and no large cash outlay is required.
    • The asset is not owned by the company.
    • Leasing includes an interest.
  • Cut overhead spending that does not reflect on outputs: These costs will not reduce production capacity, and cash payments will be reduced.
    • Future demand may be reduced by failing to promote the products effectively.

A Permanent Increase in Working Capital

  • If a business expands, higher stock levels will be needed, and a higher level of on-credit products will be sold.
  • This increase in working capital is likely to be permanent.

An Evaluation – Working Capital

  • No correct level of working capital for all businesses. Business requirements for working capital will depend on the length of the working capital cycle mainly.
  • Too much liquidity is wasteful.
  • Too little liquidity can lead to business failure.