To make it straight forward, cash flow forecasts can be beneficial for a firm as it states the following:
- How much money is flowing IN and OUT of the firm.
- The closing balance after every month.
- How much more money is needed for paying bills, repaying loans or for buying fixed assets.
- How much money the firm needs to borrow from the bank in order to avoid insolvency (the lack of financial resources)?
- MOST IMPORTANTLY... The Liquidity of the firm.
Cash flow forecasts are useful in these situations:
• Starting up a business:
When starting a business, the owner will need to know how much cash will be needed in the first few months of operation. This is a very expensive time for new businesses as premises have to be purchased or rented, machinery must be purchased or hired, stocks must be built up and advertising and promotion costs will be necessary to make consumers aware of the product. New businesses are often unsuccessful because the owner does not realize how much cash is needed in the first few crucial months.
• Keeping the bank manager informed:
Banks provide loan to businesses. However, before bank managers will lend any money, they need to see the firm’s cash flow forecast. This is particularly true of a new business. The bank manager will need to see how big a loan or overdraft is needed, when it is needed, how long the finance is needed for and when it might be repaid. (It is very rare for a bank to lend to a business unless a cash flow forecast is produced which shows all these things.)
• Running an existing business:
Any business can run out of cash and require an overdraft, because of an expensive fixed asset being bought or a fall in sales. Borrowing money to be planned in advance, so that the lowest rates of interest can be arranged. Telling the bank today that a loan is needed tomorrow, and this could lead to the bank either refusing the loan or charge high alternative but to pay these rates. If the business exceeds the overdraft limit from the bank without informing the bank manager first, the bank could insist that the overdraft is repaid immediately and this could force the business to close.
• Managing cash flow:
Too much cash held in the bank account of a business means that this capital could be better used in other areas of the business. If it seems that the business is likely to have a very high bank balance, the accountant could decide to pay off loans to help to reduce interest charges. Another option would be to pay creditors quickly to take advantage of possible discounts.
Cash Flow Forecasts (overall):
• Shows forecasted cash inflows and cash outflows
• Net cash flow = cash inflow – cash outflow
• Help managers plan ahead
• New businesses will need to provide one to obtain bank finance
• Loans can be arranged if a negative cash flow is forecast
Example Graph:
• A positive net cash flow will increase the closing bank balance.
• A negative net cash flow (as February) will reduce the bank balance.
• Each closing bank balance becomes the opening bank balance for the next month.
• The bank account becomes overdrawn in February.
For further information, visit:
http://www.thetimes100.co.uk/theory/theory--budgets-cash-flow-forecasts--116.php
There is a clear example of a detailed cash flow forecast.
