Cash flow forecasts are the ultimate management tool, enabling you to anticipate potential financial difficulties and make better business decisions.
They are also particularly useful for optimizing the company's financing and investment solutions, thereby reducing financial charges and banking costs.
1. Risks associated with the absence of cash flow forecasts
Company directors and finance departments are used to managing cash on a day-to-day basis, and sometimes have to bear the financial costs of banking operations: exceeding ceilings, financial charges...
Failure to draw up short-, medium- and long-term cash flow forecasts can have damaging consequences for the company:
- Failure to meet commitments to partners ;
- High financial expenses
- Lack of visibility between collections and payment of supplier debts
- Failure to optimize potential cash surpluses (loss of opportunity)
- Anticipation of possible future difficulties, decision-making and information for partners (employees, suppliers, administration, etc.).
2. The usefulness of cash flow forecasts
Whatever the situation and size of the company, cash flow forecasts are a real asset. If the company has financial surpluses, cash flow forecasts should enable it to take advantage of opportunities. If the company has significant needs, forecasts will enable it to reduce its costs.
As a result, cash flow forecasts are :
- a tool for anticipation: they are a steering tool for management, enabling them to anticipate possible liquidity crises and thus prevent a state of suspension of payments.
- an optimization tool: they enable the manager to select and negotiate financing and investment solutions that will lead to a reduction in the cost of debt and banking services
3. The different types of cash flow forecasts
There are two types of forecasts:
- short-term cash flow forecasts: weekly, quarterly, for example. They can be used for several purposes. Firstly, they can be used to implement technical adjustment measures: organizing supplier payments, setting up financing already authorized, etc. They can also be a very useful leading management indicator.
- long-term cash flow forecasts: half-yearly, annual, for example. A long-term view of cash flow should enable the company to adjust its «development» expenditure to its financial possibilities. Cash flow forecasting is very important for consolidating relations with financial partners.
4. The different stages in preparing cash flow forecasts
4.1 Information gathering
The first step in drawing up a cash flow forecast is to gather information such as :
– operating and investment budget
- The cash budget is the definition, in cash terms, of the company's operating, investment and financing budget.
- These budgets must be monthlyized to enable cash flow forecasts to be drawn up.
– N-1 balance sheet
- The previous year's balance sheet is required to position cash inflows and outflows resulting from payables and receivables at the balance sheet date.
– Payment deadlinest. They are the key parameter in the construction of cash flow forecasts.
The aim is to identify the payment times for the company's various products and expenses:
- customer receipts
- payment of purchases (local, foreign, with different payment terms)
- payment of wages
- payment of taxes
- payment of social security contributions
- other
For each of these operations, it will be necessary to obtain both contractual and observed lead times. The creation of a history of cash receipts and disbursements will enable us to validate the forecasts we draw up.
- other information
Last but not least, you will need forecasts for certain events, such as capital increases, dividend distributions, asset disposals, loan repayments, major investments, etc.
4.2 Forecast construction
The operating budget (like the accounts) is drawn up on the basis of expenditure and revenue commitments, in other words, expenses booked and sales achieved.
The cash flow budget translates these commitments into cash receipts and disbursements, taking into account payment deadlines.
The cash flow budget can be built around four main components:
4.2.1 Cash receipts
Based on the monthly operating budget and payment terms (theoretical or observed), forecast cash receipts will be constructed according to the following logic:
- Invoiced sales are translated into cash receipts according to the terms of payment. It is also recalculated inclusive of VAT, since the amount received from the customer includes VAT (except in the case of VAT withholding).
- The use of an average payment term is only possible if customers have homogeneous commercial conditions and behaviors. If this is not the case, sales will have to be segmented, as in the case, for example, of the same product sold on credit to business customers and in cash to private customers.
- It is also important not to omit the settlement of receivables on the balance sheet at December 31 N-1, paid in the following year, from the first months of the year.
4.2.2 Operating cash outflows
Disbursement forecasts will be drawn up according to the same logic:
- Inclusion of debts shown on the balance sheet at 12/31/N - 1, such as trade payables, social security charges payable, taxes payable, etc,
- Disbursements determined on a VAT-inclusive basis, for expenses subject to VAT.
A few precautions should be taken:
- if recurring expenses (subscriptions) have been included in the operating budget (as is often the case with monthly payments), they should be deleted. In addition, particular attention should be paid to the frequency of payment of certain expenses, such as 13th month or year-end bonus payments to employees, annual or quarterly rent payments, and social security payments (monthly or quarterly).
- depreciation and amortization will be disregarded as they do not generate cash outflows.
Taxes and duties, such as VAT collected or deductible, relating to each cash inflow and outflow can be tracked separately.
4.2.3 The global budget as a management tool
A summary table is drawn up on the basis of the three budgets previously constructed. It also shows the bank position at the beginning and end of each month.
As with a financing plan, the cash flow budget is drawn up in 2 versions:
- an initial version, highlighting cash surpluses and deficits ;
- an «adjusted» version, taking into account the measures taken to cushion these surpluses and deficits (for example, setting up overdrafts, mobilizing receivables, etc.).
It's important to draw up cash flow forecasts on a rolling rather than static basis. In this way, the forecast cash inflow and outflow situation is adjusted at the end of the month to take account of actual cash flows. Unrealized forecasts (e.g. uncollected customer receipts) will be carried forward to the following month, and the cash balance adjusted accordingly.).
5. cash flow forecasting tools
The construction of cash flow forecasts lends itself well to the use of several tools connected to your accounting and to data imported from your bank monitoring.
Forecasts of cash receipts and disbursements can be obtained from your accounting software, thanks to the correct setting of payment deadlines. Some software packages, such as Odoo, can help in this respect. These data will complement your sales and purchasing forecasts, taking into account payment deadlines.
Tools such as Excel can be used to automate the calculation of cash flow forecasts. To do this, the operating forecasts need to be integrated into a specific tab, and the corresponding cash flows calculated (using appropriate formulas).
What's more, the construction of the summary table can be fully automated by retrieving the cash receipts and disbursements tables.
This tool also allows you to run numerous simulations by varying certain parameters, such as settlement times, for example.
Actual results can be monitored by periodically analyzing variances between actual results and cash flow forecasts, which in turn enables certain operational decisions to be taken. For example, repeated late payment by certain customers (or groups of customers) should lead to a review of collection policy.
Conclusion
Drawing up cash flow forecasts, especially in these times of crisis, can prove to be a key factor in the success of your business. The managers in charge will need to collect all relevant information as exhaustively as possible, and monitor achievements as they occur. They must use it as a decision-making and negotiation tool with partners.
About Moore Senegal
Moore Sénégal is a human-scale auditing and consulting firm with services tailored to the needs of businesses. Our chartered accountants and consultants have held finance management positions and have been confronted with cash management issues. They can provide you with pragmatic advice and the right tools.
