Cash flow forecasting

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Cash flow forecasting is the process of obtaining an estimate of a company's future

Cash flow forecasting is an element of

Cash flow forecasting helps management forecast (predict) cash levels to avoid insolvency. The frequency of forecasting is determined by several factors, such as characteristics of the business, the industry and regulatory requirements.[2] In a stressed situation, where insolvency is near, forecasting may be needed on a daily basis.

Key items and aspects of cash flow forecasting:

• Identify potential shortfalls in cash balances in advance.
• Make sure that the business can afford to pay suppliers and employees - Delayed payments to suppliers and employees can cause a chain effect of decreased sales due to lack of e.g. inventory.
• Spot problems with customer payments—preparing the forecast encourages the business to look at how quickly customers are paying their debts, see Working capital.
• As a discipline of
  cash flow forecast is a management process
  , similar to preparing business budgets.
• External stakeholders, such as banks, may require a regular forecast if the business has a bank loan.

Corporate finance

In the context of corporate finance, cash flow forecasting is the modeling of a company or entity's future financial liquidity over a specific timeframe: short term generally relates to working capital management, and longer term to asset and liability management.

Cash usually refers to the company's total bank balances, but often what is forecast is

Methods

Cashflows may be forecast directly, as well as by several indirect methods.

The direct method of cash flow forecasting schedules the company's cash receipts and disbursements (R&D). Receipts are primarily the collection of accounts receivable from recent sales, but also include sales of other assets, proceeds of financing, etc. Disbursements include payroll, payment of accounts payable from recent purchases, dividends and interest on debt. This direct R&D method is best suited to the short-term forecasting horizon of 30 days ("or so") because this is the period for which actual, as opposed to projected, data is available.^[3]

The three indirect methods are based on the company's projected income statements and balance sheets.

• The adjusted net income (ANI) method starts with operating income (EBIT or EBITDA) and adds or subtracts changes in balance sheet accounts such as receivables, payables and inventories to project cash flow.
• The
  cash account
  ; if all the other balance sheet accounts have been correctly forecast, cash will be correct, also.
• The accrual reversal method (ARM), is similar to the ANI method. Here, instead of using projected balance sheet accounts, large accruals are reversed and cash effects are calculated based upon statistical distributions and algorithms. This allows the forecasting period to be weekly or even daily. It also eliminates the cumulative errors inherent in the direct, R&D method when it is extended beyond the short-term horizon. But because the ARM allocates both accrual reversals and cash effects to weeks or days, it is more complicated than the ANI or PBS indirect methods. The ARM is best suited to the medium-term forecasting horizon.^[4]

Both the ANI and PBS methods are suited to the medium-term (up to one year) and long-term (multiple years)

One observation, ^[citation needed] re the commercial tools available is that while these can offer automation and predictive capabilities, there are limitations to their accuracy, especially in areas that involve human behaviour or subjective factors. For instance, predicting when customers will pay their bills accurately can be challenging due to various factors that influence payment behaviour. AI tools heavily rely on historical patterns and predefined rules, which may not always capture the complexities of real-world situations accurately. Moreover, AI tools may lack the flexibility and customization options provided by Excel, as they are typically designed to work within predefined frameworks and may not easily adapt to unique business requirements.

References

See also

• Cash-flow diagram
• Cash flow at risk
• Cash is king
• Financial analyst § Corporate and other
• Financial forecast
• Financial modeling § Accounting
• Forecast period (finance)
• Valuation using discounted cash flows § Determine cash flow for each forecast period
• Mid-year adjustment
• Owner earnings
• Operating budget
• Outline of finance § Financial modeling