the meaning and purpose of cash flow forecasts

5.3 Forecasting and Managing Cash Flows – Cash Flow Forecasts

Objective

Students will be able to:

• Define a cash‑flow forecast and explain why it is prepared.
• Interpret a simple forecast – calculate opening, inflow, outflow and closing balances.
• Amend a forecast using “what‑if” scenarios and assess the impact on liquidity.
• Use the forecast to identify cash‑flow problems and suggest realistic improvement actions.
• Link cash‑flow forecasting to other parts of the Cambridge 9609 syllabus (working‑capital, sources of finance, budgeting).

1. What is a Cash‑Flow Forecast?

• A projected statement of the cash inflows and outflows of a business over a future period (usually weekly, monthly or quarterly).
• It records the timing of cash movements – not profit – and therefore focuses solely on liquidity.

2. Why Prepare a Cash‑Flow Forecast?

3. Key Components of a Cash‑Flow Forecast

1. Opening cash balance – cash on hand at the start of the period.
2. Cash inflows
   • Cash sales
   • Collections from credit sales
   • Loan proceeds
   • Asset disposals
   • Other income (interest received, refunds, etc.)
3. Cash outflows
   • Payments to suppliers
   • Wages and salaries
   • Operating expenses (rent, utilities, marketing)
   • Loan repayments and interest
   • Capital expenditure
   • Tax payments
   • Irregular items (insurance premium, annual licence fees)
4. Closing cash balance – Opening balance + Total inflows – Total outflows.

4. Simple Cash‑Flow Forecast – Example

5. Interpreting a Simple Cash‑Flow Forecast

• Trend analysis – Is the closing balance growing (surplus) or falling (possible deficit)?
• Cash‑deficit warning – A closing balance below a pre‑agreed threshold (e.g., £5,000) signals a need for short‑term finance.
• One‑off spikes – Large outflows should be identified and explained (e.g., purchase of new equipment).
• Opening balance adequacy – Very low opening cash limits the firm’s ability to absorb unexpected expenses.

Checklist for Calculating Balances

1. Write down the opening balance.
2. Add all cash inflows for the period.
3. Subtract all cash outflows for the period.
4. Result = closing balance.
5. Carry the closing balance forward as the opening balance for the next period.

Simple Decision‑Tree for a Low Closing Balance

If closing balance < £5,000 →

• Can any receivables be collected earlier? (discount for early payment)
• Can any payables be delayed without penalty? (extend supplier terms)
• Is there a short‑term financing option available? (overdraft, factoring)
• Can non‑essential spending be postponed?

6. Amending a Cash‑Flow Forecast – “What‑If” Exercise

Assume the business expects a slowdown in collections: only 40 % of credit sales (£12,000) will be collected in the month, instead of 60 %.

Result: the closing balance falls from £14,500 to £12,300, highlighting a cash‑flow risk that may require an overdraft or a delay in non‑essential spending.

7. Steps to Prepare a Cash‑Flow Forecast

1. Choose the forecast horizon (e.g., 12 months) and the reporting frequency (monthly for A‑Level).
2. Gather historical cash‑receipt and cash‑payment data.
3. Forecast sales and decide the expected collection period (e.g., 30 days).
4. List all expected cash outflows, separating fixed costs (rent, salaries) from variable costs (raw‑material purchases).
5. Enter the opening cash balance for the first period.
6. Calculate total inflows and outflows for each period and compute the closing balance.
7. Carry the closing balance forward as the opening balance for the next period.
8. Identify any projected deficits and plan corrective actions (overdraft, factoring, delayed purchases, etc.).
9. Review and update the forecast regularly (at least monthly) to reflect actual performance.

8. Methods for Improving Cash Flow

Once a forecast highlights a shortfall, the business can take one or more of the following actions.

• Speeding up receivables
  • Offer a small discount for early payment (e.g., 2 % if paid within 10 days).
  • Introduce electronic invoicing and direct‑debit arrangements.
  • Use **dynamic discounting** – the discount rate varies with the speed of payment.
  • Consider **factoring** (selling invoices to a third party) to obtain cash immediately.
• Extending payables
  • Negotiate longer credit terms with suppliers (e.g., from 30 to 45 days).
  • Ask for staggered loan repayments to match cash inflows.
  • Use a revolving overdraft to bridge the gap while waiting for supplier invoices.
• Reducing inventory (Just‑In‑Time)
  • Hold less stock by synchronising purchases with production schedules.
  • Adopt a “stock‑turnover” target to free cash tied up in raw materials and finished goods.
• Short‑term financing
  • Overdraft facilities
  • Bank loans or lines of credit
  • Invoice discounting / factoring (see above)
• Cash‑flow‑focused budgeting
  • Zero‑based cash budgeting – each cash item must be justified each period.
  • Rolling forecasts – update the forecast continuously as new information becomes available.

9. Links to Other Finance Topics (Cross‑Reference Box)

10. Common Pitfalls and How to Avoid Them

• Over‑optimistic sales forecasts – Use realistic growth rates and factor in seasonality.
• Ignoring timing differences – Distinguish between when sales are recorded (accrual) and when cash is actually received.
• Excluding irregular outflows – Include annual items such as insurance premiums, tax payments or loan instalments.
• Failing to update the forecast – Review monthly and adjust assumptions to reflect actual performance.
• Arithmetic errors – Use the checklist in section 5 to verify that Opening + Inflows – Outflows = Closing.

11. Quick Check – Practice Question

Data for April

• Opening cash balance: £8,000
• Cash sales: £5,000
• Collections from credit sales (60 % of £12,000 credit sales): £7,200
• Supplier payments: £6,000
• Wages: £3,500
• Rent and utilities: £1,200

Calculate the closing cash balance for April.

Solution:

Total inflows = £5,000 + £7,200 = £12,200
Total outflows = £6,000 + £3,500 + £1,200 = £10,700
Closing balance = £8,000 + £12,200 – £10,700 = £9,500

12. Diagram – Cash‑Flow Forecasting Process

1️⃣ Estimate sales & collection period
   ↓
2️⃣ List expected cash inflows
   ↓
3️⃣ List expected cash outflows
   ↓
4️⃣ Record opening cash balance
   ↓
5️⃣ Compute closing balance (Opening + Inflows – Outflows)
   ↓
6️⃣ Analyse results
   ├─ Surplus? → Plan investment or repayment
   └─ Deficit? → Identify remedial actions (overdraft, speed receivables, delay payables)
   ↓
7️⃣ Amend assumptions (what‑if) & repeat
   ↓
8️⃣ Implement cash‑flow improvement actions