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Making Cash Flow Forecasts

1. Importance of Cash Flow


When planning the short- or long-term funding requirements of a business, it is more important to forecast the likely cash requirements than to project profitability etc. Whilst profit, the difference between sales and costs within a specified period, is a vital indicator of the performance of a business, the generation of a profit does not necessarily guarantee its development, or even the survival. Bear in mind that more businesses fail for lack of cash flow than for want of profit.

2. Cash Flow vs Profit


Sales and costs and, therefore, profits do not necessarily coincide with their associated cash inflows and outflows. While, a sale may have been secured and goods delivered, the related payment may be deferred as a result of giving credit to the customer. At the same time, payments must be made to suppliers, staff etc., cash must be invested in rebuilding depleted stocks, new equipment may have to be purchased etc. he net result is that cash receipts often lag cash payments and, whilst profits may be reported, the business may e!perience a short-term cash shortfall. "or this reason it is essential to forecast cash flows as well as project likely profits. he following simplified e!ample illustrates the timing differences between profits and cash flows# Income Statement: Month 1 Sales $%&&&' *osts $%&&&' ,rofit $%&&&' () +) -&

Cashflows relating to Month 1: Month 1 Month 2 Month 3

otal

.eceipts from sales $%&&&' ,ayments to suppliers etc. $%&&&' 2et cash flow $%&&&' *umulative net cash flow $%&&&'

/& 1& $/&' $/&'

0) /& -) $)'

/& ) -) -&

() +) -& -&

his shows that the cash associated with the reported profit for 3onth - will not fully materiali4e until 3onth 0 and that a serious cash short- fall will be e!perienced during 3onth - when receipts from sales will total only %/&,&&& as compared with cash payments to suppliers of %1&,&&&. 5ur 6!l-,lan range of financial planners generate fully integrated profit 7 loss accounts with cashflow statements and balance sheets for up to five years ahead and *ashflow ,lan is a specialist cashflow planner covering -/ months ahead, with weekly projections for the initial three months.

3. Calculating Cashflow
2ormally, the main sources of cash inflows to a business are receipts from sales, increases in bank loans, proceeds of share issues and asset disposals, and other income such as interest earned. *ash outflows include payments to suppliers and staff, capital and interest repayments for loans, dividends, ta!ation and capital e!penditure. 2et cash flow is the difference between the inflows and outflows within a given period. A projected cumulative positive net cash flow over several periods highlights the capacity of a business to generate surplus cash and, conversely, a cumulative negative cash flow indicates the amount of additional cash required to sustain the business. *ashflow planning entails forecasting and tabulating all significant cash inflows relating to sales, new loans, interest received etc. and then analy4ing in detail the timing of e!pected payments relating to suppliers, wages, other e!penses, capital e!penditure, loan repayments, dividends, ta!, interest payments etc. he difference between the cash in- and out-flows within a given period indicates the net cash flow. When this net cash flow is added to or subtracted from opening bank balances, any likely short-term bank funding requirements can be ascertained. 8f you need to produce regularly-updated cashflow projections, have a look at Cashflow !lan, our range of fully-integrated cashflow planners which generate projections for -/ months ahead and incorporate a roll-forward facility to simplify updating of projections.

4. Using a Computer to Forecast Cashflow


With the aid of a computer and suitable software, a mathematical model can be used to prepare cash flow projections and project short-term banking requirements for a business. he use of a computer-based model reduces the tedium of carrying out numerous repetitive calculations and simplifies the alteration of assumptions and the presentation of results. A computer-based model can be constructed using a spreadsheet or acquired as a stand-alone package. 8f constructing a spreadsheet model, be aware that it is not as easy as it might seem to build a friendly, robust and error-free planner. A cash flow model can be used to compile forecasts, assess possible funding requirements and e!plore the likely financial consequences of alternative strategies. 9sed effectively, a model can help prevent major planning errors, anticipate problems, identify opportunities to improve cash flow or provide a basis for negotiating short-term funding from a bank. :enerally, when seeking e!ternal funding, the time hori4on covered by a set of projections should be equal to or greater than the period for which the funding is needed. he greater the amount of funding required and the longer the period of e!posure for the provider of these funds, the more comprehensive must be the supporting projections and plan. ypically, a computer model for short-term bank planning uses assumptions on sales, costs, credit, funding etc. to produce monthly cash flow projections for up to a year ahead. he initial assumptions can be readily altered to evaluate alternative scenarios. "or e!ample, a model could be used to e!plore the e!tent to which future sales could be increased whilst holding bank borrowings within predetermined limits; to assess the effects on cash flow of varying sales, costs or credit terms; or to determine the likely short-term funding requirements for a business. 5nce assumptions on sales, e!pense payments etc. have been established, a model can be used to produce the cash flow projections which, in turn, indicate the likely future cash balances or banking requirements. <owever, the quality of these projections will be completely determined by the standard and reliability of the underlying assumptions. "or e!ample, if forecasts for sales, working capital or costs are unrealistic or inadequately researched, then the value of the model=s output is greatly diminished. An impressive set of projections is of little benefit if it is unsupported by e!perience or research or based on mere speculation. 8n fact, they could be very damaging, or even destroy the business.

. Planning to Pro!ect Cashflow


>efore using a model for short-term cash flow forecasting, a manager or

entrepreneur should# ?ecide the central purpose of the e!ercise $internal planning and control, negotiate a loan etc.'. 8dentify the target audience $directors, bank manager etc.' Set the time intervals and hori4on $e.g. monthly for twelve months' Sort out the level of detail required. *heck that all the necessary key assumptions and data are to hand and have been adequately researched. *ompile opening balances for all items which will involve cash flows within the forecasting period. hink through the likely impact of the critical assumptions on the cash flow projections. 8f necessary, prepare preliminary forecasts manually to confirm their overall direction and consider the underlying strategic issues relating to sales, funding, costs, stocks etc. As a guide, sales forecasts and debtor 7 creditor terms are likely to have the most profound impacts on short-term cash flows.

o produce regularly-updated cashflow projections, have a look at Cashflow !lan, our range of fully-integrated cashflow planners which generate projections for -/ months ahead and incorporate a roll-forward facility to simplify updating of projections.

". Planning Pitfalls when Forecasting Cash Flow


When preparing cash flow projections, be aware of the dangers of# 5verstating sales forecasts 9nderestimating costs and delays likely to be encountered 8gnoring historic trends or performances by debtors etc. 3aking unduly-optimistic assumptions about the availability of bank loans, credit, grants, equity etc. Seeking spurious accuracy whilst failing to recogni4e matters of strategic importance

hese problems can arise as the result of a lack of foresight or knowledge, or because of e!cessive optimism. hey can lead to under-estimation of the cash and other resources required to sustain or develop a business with potentially disastrous consequences. When forecasting bank requirements and preparing cash flow projections, realistic views should always be taken about future prospects. here is often merit in compiling @worst@ case projections to complement @most likely@ or @best@ forecasts and to accept that the @worst@ case might occur and to plan accordingly.

#. $a%s of Improving Cash Flow


5nce the cash flow projections have been prepared, they should be critically e!amined and used as a management tool to control and improve the business=s e!pected cash position. 8ssues which might be e!amined include the following#

3&' $a%s of Improving (et Cashflow


-. 8ncrease sales $particularly those involving cash payments'. /. .educe direct and indirect costs and overhead e!penses. 0. ?efer discretionary projects which cannot achieve acceptable cash paybacks $e.g. within one year AAA'. 1. 8ncrease prices especially to slow payers. ). .eview the payment performances of customers - involve sales force. +. >ecome more selective when granting credit. (. Seek deposits or multiple stage payments. B. .educe the amountCtime of credit given to customers. D. >ill as soon as work has been done or order fulfilled. -&. 8mprove systems for billing and collection. --. 9se the B&C/& rule to control inventories, receivables and payables. -/. 8mprove systems for paying suppliers. -0. :enerate regular reports on receivable ratios and aging. -1. 6stablish and adhere to sound credit practices - train staff. -). 9se more pro-active collection techniques. -+. Add late payment charges or fees where possible. -(. 8ncrease the credit taken from suppliers. -B. 2egotiate e!tended credit from suppliers. -D. 3ake prompt payments only when worthwhile discounts apply. /&. .educe inventory $stock' levels and improve control over workin-progress. /-. Sell off or return obsoleteCe!cess inventory. //. 9tili4e factoring, or discount facilities, to accelerate receipts from sales. /0. ?efer or re-stage all capital e!penditure. /1. 9se alternative financing methods, such as leasing, to gain access to the use $but not ownership' of productive assets. /). .e-negotiate bank facilities to reduce charges. /+. Seek to e!tend debt repayment periods. /(. 2et off or consolidate bank balances. /B. Sell off surplus assets or make them productive. /D. 6nter into sale and lease-back arrangements for productive assets. 0&. ?efer dividend payments. 0-. .aise additional equity.

0/. *onvert debt into equity. 00. 3ake medium- and short-term cashflow forecasts and update them regularly

5nce a set of cash flow projections have been prepared, a computer model, like 6!l-,lan and *ashflow ,lan, can be used to e!plore the impact of alternative measures, such as those described above, on the net cash flow and on bank requirements.

). Conclusion
*heck out the quotations on our page of Euotations to read what other people have to say about cash. "or further information on planning issues, see other papers in this series which deal with financial planning, strategic planning, devising business strategies, managing working capital and the preparation of business plans.

*. Intro+ucing Invest,-ech . Plan$are


8nvest- ech develops and sells a range of financial planning packages - 6!l-,lan and *ashflow ,lan - for businesses of all si4es 7 types. rial versions of all products can be downloaded from our ,lanWare site and many other sources on the =2et. We also offer an e!tensive range of commercial software for writing business plans, market planning, assessing business ideas and evaluating strategies. ,lanWare also features# ,apers on cash flow, financial, strategic and business planning topics. Advice on getting new business ideas, managing working capital, devising business strategies and much more. Free 5nline "inancial ,lanner to produce =first-cut= five-year projections. ,ages devoted to famous business quotations and e!amples of bad business advice and mistakes.

Cashflow management: the basics


Cash inflows and cash outflows 8deally, during the business cycle, you will have more money flowing in than flowing out. his will allow you to build up cash balances with which to plug cashflow gaps, seek e!pansion and reassure lenders and investors about the health of your business. Fou should note that income and e!penditure cashflows rarely occur together, with inflows often lagging behind. Four aim must be to speed up the inflows and slow down the outflows. Cash inflows

payment for goods or services from your customers receipt of a bank loan interest on savings and investments shareholder investments increased bank overdrafts or loans

Cash outflows

purchase of stock, raw materials or tools wages, rents and daily operating e!penses purchase of fi!ed assets - ,*s, machinery, office furniture, etc loan repayments dividend payments income ta!, corporation ta!, GA and other ta!es reduced overdraft facilities

3any of your regular cash outflows, such as salaries, loan repayments and ta!, have to be made on fi!ed dates. Fou must always be in a position to meet these payments, to avoid large fines or a disgruntled workforce. o improve everyday cashflow you can#

ask your customers to pa" sooner - see our guide on in#oicing and pa"ment terms chase debts promptly and firmly - see our guide on getting paid on time use factoring - see our guide on debt factoring and in#oice discounting: the basics ask for e$tended credit terms with suppliers - see our guide on how to negotiate the right deal with suppliers

order less stock but more often - see our guides on stock control and in#entor" and manufacturing inno#ation lease rather than buy equipment - see our guide on how to decide whether to lease or bu" assets improve profitability

Fou can also improve cashflow by increasing borrowing, or putting more mone" into the business. his is acceptable for coping with short-term downturns or to fund growth in line with your business plan, but shouldn=t form the basis of your cash strategy.

Cashflow management/ the 0asics


Cash management in action he following simple e$ample shows how a small, profitable business can run into unforeseen cashflow problems when it takes on a new large order. HFI manufacturer is a small but profitable gift designer and supplier with three full-time staff $including the two owners'. 8t outsources production, but supplies the raw materials itself to save on costs. 8t then finishes and packages the final product on site. HFI does not have any loans or overdrafts. 8t has a long-term customer base of small gift shops and visitor centres. HFI suddenly wins a large order to supply bespoke wall plaques for a chain of stores. he contract promises to double its turnover. he team takes on an additional employee and works flat out to meet the deadlines. 8t doesn=t notice an impending cashflow crisis resulting from a fall in repeat orders from e!isting customers combined with a jump in raw material costs. o make matters worse, the new client keeps changing its mind about designs. A misunderstanding means the first run of goods is rejected, causing a delay in payment and increased production costs. HFI orders additional materials to make up the shortfall in the run. >y the time the order is complete, HFI is running an e!pensive overdraft. ,rofit margins have been squee4ed to the limit and it has lost several of its e!isting customers. A downturn in the fortunes of the retail chain means that it doesn=t place any further orders. After a lot of hard work, HFI finds itself back where it was five years earlier. ighter cashflow management would have highlighted the fall in repeat orders and rise in raw material costs. HFI would also have benefited from a client contract that included#

milestone payments and penalty provisions for changes such as those to designs - eg increased fees sharing the cost of additional materials with the new client or getting the client to pay for them

%ind an illustration of the impact of the new order on &'()s cashflow .

Cashflow management/ the 0asics


Introduction

*ash is the o!ygen that enables a business to survive and prosper, and is the primary indicator of business health. While a business can survive for a short time without sales or profits, without cash it will die. "or this reason the inflow and outflow of cash need careful monitoring and management. his guide looks at the key elements of cashflow and at how effective cashflow management will help protect the financial security of your business. 8t outlines the steps that you can take when dealing with your customers, suppliers and stakeholders to improve cashflow. 8t also highlights common cashflow problems and how to avoid them.

Cashflow management/ the 0asics


Cashflow problems and how to a#oid them 2o matter how effective your negotiations with customers and suppliers, poor business practices can put your cashflow at risk. Jook out for#

!oor credit controls - failure to run credit checks on your customers is a high-risk strategy, especially if your debt collection is inefficient. See our guide on getting paid on time.

%ailure to fulfil "our order - if you don=t deliver on time or to specification you won=t get paid. 8mplement systems to measure production efficiency and the quantity and quality of stock you hold and produce - see our guide on setting business targets.

Ineffecti#e marketing - if your sales are stagnating or falling, revisit your marketing plan. See our guides on how to create "our marketing strateg" and how to reach "our customers effecti#el".

Inefficient ordering ser#ice - make it easy for your customers to do business with you. Where possible, accept orders over the telephone or 8nternet. 6nsure catalogues and order forms are clear and easy to use.

!oor management accounting - keep an eye on key accounting ratios that will alert you to an impending cashflow crisis or prevent you from taking orders you can=t handle. See our guides on how to identif" potential cashflow problems and how to a#oid the problems of o#ertrading.

Inade*uate supplier management - your suppliers may be overcharging, or taking too long to deliver. *reate a supplier management system - see our guide on how to manage "our suppliers.

!oor control of gross profits or o#erhead costs.

Cashflow management/ the 0asics


Manage income and e$penditure 6ffective cashflow management is as critical to business survival as providing services or products. >elow are some of the key methods to help reduce the time gap between e!penditure and receipt of income. Customer management

?efine a credit polic" that clearly sets out your standard pa"ment terms. See our guide on in#oicing and pa"ment terms. 8ssue invoices promptly and regularly chase outstanding payments. 9se an aged debtor list to keep track of invoices that are overdue and monitor your performance in getting paid. See our guide on getting paid on time.

*onsider e!ercising your right to charge penalt" interest for late payment. +ownload the guide to late pa"ment legislation from the Better !a"ment !ractice Campaign website ,!+%-. Fou can also find a late pa"ment penalt" interest calculator at the Better !a"ment !ractice Campaign website.

*onsider offering discounts for prompt payment. 2egotiate deposits or staged pa"ments for large contracts. 8t=s in your customers= interests that you don=t go out of business trying to meet their demands. *onsider using a third party to buy your invoices in return for a percentage of the total. See our guide on debt factoring and in#oice discounting: the basics.

Supplier management Ask for e$tended credit terms. :iving your suppliers incentives such as large or regular orders may help, but make sure you have a market for the orders you=re placing. Alternatively, consider reducing stock le#els and using .ust/in/time systems - see our guide on manufacturing inno#ation. Fou can also see our guides on stock control and in#entor" and how to manage "our suppliers. Taxation 8f you are registered for GA , it makes sense to buy major items at the end rather than the start of a GA period. his can often improve your cashflow, because you can set the GA on the purchase off against the GA you charge on sales. his may help plug a temporary cashflow gap. Asset management

*onsider leasing fi!ed assets, eg equipment, or buying them on hire purchase. >uying outright can result in a huge drain on cash in the first year of business. See our guide on how to decide whether to lease or bu" assets. 0ead tips on getting customers) cash faster at the Better !a"ment !ractice Campaign website.

Cashflow management/ the 0asics


he principles of cashflow forecasting *ashflow forecasting enables you to predict peaks and troughs in your cash balance. 8t helps you to plan borrowing and tells you how much surplus cash you=re likely to have at a given time. 3any banks require forecasts before considering a loan. Elements of a cashflow forecast he cashflow forecast identifies the sources and amounts of cash coming into your business and the destinations and amounts of cash going out over a given period. here are normally two columns listing forecast and actual amounts respectively. he forecast is usually done for a year or quarter in advance and divided into weeks or months. 8n e!tremely difficult cashflow situations a daily cashflow forecast might be helpful. 8t is best to pick periods during which most of your fi!ed costs - such as salaries - go out. he forecast lists#

receipts payments e!cess of receipts over payments - with negative figures shown in brackets opening bank balance closing bank balance

8t is important to base initial sales forecasts on realistic estimates - see our guide on how to forecast and plan "our sales. 8f you have an established business, an acceptable method is to combine sales revenues for the same period -/ months earlier with predicted growth. +ownload our sample cashflow pro.ection spreadsheet ,&1S- . 2ote that all forecast figures must relate to sums that are due to be collected and paid out, not invoices actually sent and received. he forecast is a live entity. 8t will need adjusting in line with long-term changes to actual performance or market trends. Accounting software Accounting software will help you prepare your cashflow forecast, allowing you to update your projections if there=s a change in market trends or your business fortunes. ,lanning for seasonal peaks and troughs is simplified and you can also make @what if@ calculations. 3ost banks require profit and balance sheet forecasts as well as cashflow. 3any accounting packages will assist with preparing these documents. See our guide on accounting software.

Cashflow management/ the 0asics

2sing "our cashflow forecast as a business tool A cashflow forecast can be an invaluable business tool if it is used effectively. >ear in mind that it is dynamic - you will need to change and adjust it frequently depending on business activity, payment patterns and supplier demands. 8t=s helpful to set up a regular re#iew of the forecast, changing the figures in light of your sales, purchases and staff costs. Jegislation, interest rates and ta! changes will also impact on the forecast. <aving a regular review of your cashflow forecast will enable you to#

see when problems are likely to occur and sort them out in advance identify any potential cash shortfalls and take appropriate action ensure you have sufficient cashflow before you take on any major financial commitment

Using a cashflow forecast to avoid overtrading <aving an accurate cashflow forecast will help ensure that you can overtrading. Fou will know when you have sufficient assets to take as importantly, when you need to consolidate. his will enable you suppliers happy. See our guide on how to a#oid the problems of achieve stead" growth without on additional business - and, just to keep staff, customers and o#ertrading.

8t is important that you incorporate warning signals into your cashflow forecast. "or e!ample, if predicted cash levels come close to your overdraft limits, this should sound an alarm and trigger action to bring cash back to an acceptable level. See our guide on how to identif" potential cashflow problems. 8deally, you should always have a contingenc" plan, such as retaining a minimum amount of cash in the business, perhaps in an interest-earning account. his @rainy day@ money can be used to meet short-term cash shortages.

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Cash Manageme nt
Oracle Cash Management is an enterprisewide solution for managing liquidity and controlling cash. Cash Management gives you direct access to expected cash flows from your operational systems. You can quickly analyze enterprisewide cash management cash requirements and currency exposures, ensuring liquidity and optimal use of cash resources.

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Oracle Cash Management is part of the Oracle inancials family of applications.


F12-U314 2(5 61(1FI-4

orecast cash flows in any currency and in multiple time periods !treamline the reconciliation process Monitor for exceptions and fraud orecast "ased on historical or future transactions Manage the cash cycle efficiently and with control
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IMP<1M1(-

Cash Manageme nt
Oracle Cash Management is an enterprisewide solution for managing liquidity and controlling cash. Cash Management gives you direct access to expected cash flows from your operational systems. You can quickly analyze enterprisewide cash management cash requirements and currency exposures, ensuring liquidity and optimal use of cash resources. Oracle Cash Management is part of the Oracle inancials family of applications.
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orecast cash flows in any currency

and in multiple time periods !treamline the reconciliation process Monitor for exceptions and fraud orecast "ased on historical or future transactions Manage the cash cycle efficiently and with control
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