Cash Flow Forecast helps to ensure that the Cash Flow position of a firm is carefully monitored to identify any potential problems before they occur.
Cash Flow forecasting is an ongoing process of predicting movements of cash in and out of the business with regular updates being made when necessary.
What uses does this type of financial cash planning have?
Advantages of Cash Flow Forecast
There are several important advantages for businesses of Cash Flow Forecasting:
1. Aids financial planning. Cash Flow Forecasts will help with planning all the cash to be received by a business and all the cash outflows from the business over a period of time in the future. It is important to follow and record those movements of cash as all business activity results in a flow of cash either into the business or out of the business. Specifically, thanks for Cash Flow Forecasts, business managers will be able to plan Opening Balance, Cash Inflows, Cash Outflows, Net Cash Flow and Closing Balance.
2. Prevents Cash Flow problems. By constructing Cash Flow Forecast the liquidity and Working Capital needs of the business can be assessed month by month. This can help managers to better manage Cash Flows and Working Capital needs. Cash can be better managed by planning for periods when there might be too little cash and arranging for overdraft or short-term bank loans to avoid a liquidity crisis. Simply, plans can be put in place to provide additional finance to avoid most common Cash Flow problems.
3. Can support loan application. Any experienced investor as well as banks will require a Cash Flow Forecast as a part of the business plan of any new business venture. Therefore, producing a Cash Flow Forecast will help the new business proposal to progress beyond the initial planning stage to ultimately finance and launch a new business organization.
Disadvantages of Cash Flow Forecast
There are several disadvantages for businesses of Cash Flow Forecasting as well:
1. Poor accuracy. There are just too many factors, both regarding internal business environment and external business environment, that can negatively impact the correctness a Cash Flow Forecast. Numerical inaccuracies can occur due to a number of reasons such as:
- Poor Market Research can lead to incorrect Sales Forecasting.Â
- An undesirable marketing campaign can offend customers leading to lower Sales.Â
- Changes in fashion and tastes can bring either less or more customers to the business.Â
- The behavior of competitors can be difficult to anticipate.
- A demotivated workforce delivers poor customer service leading to poor sales.
- Mismanaged interpersonal disputes can lead to industrial actions.
- Machines failure can cause production stoppage and delays of products to customers.
2. Wild fluctuations. Unexpected increases in business costs can blow away even the most precise Cash Flow Forecast away from its course. Any unexpected changes that happen in the external environment of the business can lead to the Cash Flow Forecast being misleading. These disruptive fluctuations can include sudden spikes in production costs due to energy price increases, adverse weather or shortages of raw materials.
3. Wrong assumptions. Business managers love making positive assumptions about the future. Especially when it comes to boosting the number of products sold by the business. These overpromises are very often incorrect assumptions made in estimating the sales of the business. Perhaps, they are more based on subjective perspectives of a single manager who hopes for the best, rather than being based on solid Market Research and reliable Sales Forecasting. Being too positive with the sales numbers will lead to the cash inflow forecasts being inaccurate.
4. Numerical mistakes. Mistakes can happen in a business world and happen very often. And, because Cash Flow forecasting deals with numbers, it would be very unwise to assume that the numbers were always accurate. Specifically, simple mistakes can be easily made when typing in the numbers or copying them from other documents without double-checking and cross-checking for correctness.
In summary, Cash Flow forecasting attempts to predict the liquidity position of a business in the future based on certain assumptions. That is why there is no guarantee that predictions and assumptions made in a Cash Flow Forecast will materialize.
Hence, more accurate forecasts tend to be for the immediate and foreseeable future only because predictions of the distant future tend to be more inaccurate, hence less meaningful.
