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Cashflow Forecasting

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08 / Feb / 2012

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10 financial concepts you should master 

Here is lesson eight in unwrapping essential financial concepts and how they will help you run your business.

Cash flow forecasting

Cash flow forecasting is looking forward to see what the cash requirements of the business are going to be. It creates a model to predict whether the income will cover the cost of operations, whether a particular project will be sufficiently profitable to justify the investment and whether the business can fund the cash requirements over that period.

Cash flow forecasting requires a simple spreadsheet that starts with cash at the beginning of the period (usually the start of the month), adds the expected cash coming into the business from sales, collection of cash from invoices and loans and other financing and then subtracts the cash going out of the business for various costs (goods, rent and wages are all prime examples).

From this you will be able to work out your cash position at the end of each month and, by making assumptions about sales, costs and your ability to collect cash, your cash position at the end of the year.

What the business is looking for are dips and rises in cash flow to understand where they might have a cash flow shortfall, so that there are no surprises. It is far easier to plan ahead than it is to react when there is a cash crunch.

A manufacturing business, for example, might shut down over Christmas and typically experience a cash flow shortfall in January and February because it did not make any sales over Christmas, so there is no cash to collect in February, which might require the business to go to the bank to get a short-term overdraft. The bank will want to see when cash starts to flow in again, so the business will have to produce its cash flow forecast.

Many businesses just focus on the profit and loss budget, but that does not take into account the accrual impact of debtors and creditors on cash flow timing.

The best cash flow forecasts are done on a rolling three-month basis and it has to be done in full detail. A higher level cash flow forecast is also done for 12 months.

The longer-term cash flow forecast is important for making investment decisions around new plant and equipment, and understanding when is the best time of year to buy things.

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