Cash flow forecast → a financial plan showing the expected cash inflows and cash outflows of a business over a future period
→ A simple cash flow forecast normally contains → opening balance, cash inflows, cash outflows, net cash flow and closing balance
Opening Balance
→ Opening cash balance → the amount of cash available to the business at the beginning of a period
→ The opening balance for the first month → is usually the cash available at the start of the forecast
→ The opening balance for each following month → is the previous month’s closing balance
→ Example:
→ January closing balance = ₹4 lakh
→ February opening balance = ₹4 lakh
Calculating Net Cash Flow
→ Net cash flow → the difference between total cash inflows and total cash outflows
→ Formula:
→ Net cash flow = Total cash inflows − Total cash outflows
→ If inflows > outflows → positive net cash flow
→ If outflows > inflows → negative net cash flow
→ Example:
→ Cash inflows = ₹8 lakh
→ Cash outflows = ₹6 lakh
→ Net cash flow = ₹8 lakh − ₹6 lakh = ₹2 lakh
→ Example:
→ Cash inflows = ₹5 lakh
→ Cash outflows = ₹7 lakh
→ Net cash flow = ₹5 lakh − ₹7 lakh = −₹2 lakh
Calculating Closing Balance
→ Closing cash balance → the amount of cash expected to remain at the end of a period
→ Formula:
→ Closing balance = Opening balance + Net cash flow
→ Therefore →
→ Closing balance = Opening balance + Cash inflows − Cash outflows
→ Example:
→ Opening balance = ₹3 lakh
→ Cash inflows = ₹7 lakh
→ Cash outflows = ₹5 lakh
→ Net cash flow = ₹2 lakh
→ Closing balance = ₹3 lakh + ₹2 lakh = ₹5 lakh
Calculating the Opening Balance
→ The opening balance can be found from the previous period’s closing balance
→ Formula:
→ Opening balance of current period = Closing balance of previous period
→ Example:
→ March closing balance = ₹6 lakh
→ April opening balance = ₹6 lakh
Interpreting a Cash Flow Forecast
→ A cash flow forecast allows managers to identify → cash shortages, cash surpluses and changes in liquidity
→ Positive net cash flow → more cash is expected to enter than leave the business during the period
→ Negative net cash flow → more cash is expected to leave than enter the business during the period
→ A positive closing balance → indicates that the business is forecast to have cash available at the end of the period
→ A negative closing balance → indicates a forecast cash shortage → the business may need additional finance
→ Example:
→ Opening balance = ₹2 lakh
→ Inflows = ₹4 lakh
→ Outflows = ₹7 lakh
→ Net cash flow = −₹3 lakh
→ Closing balance = −₹1 lakh
→ Analysis: negative closing balance → business may be unable to meet payments → management needs to arrange additional finance or reduce cash outflows
Identifying Cash Shortages
→ A cash shortage occurs when → the closing cash balance becomes negative or is too low to meet expected payments
→ Possible solutions →
→ arrange a bank overdraft
→ obtain a bank loan
→ delay non-essential expenditure
→ negotiate longer payment periods with suppliers
→ accelerate collection from customers
→ reduce inventory purchases
→ inject additional owners’ capital
→ Example: A business forecasts a closing balance of −₹3 lakh in June → management could arrange an overdraft before June
→ Analysis: early identification → time to arrange finance → essential payments can be made → risk of business failure is reduced
Identifying Cash Surpluses
→ A cash surplus occurs when → cash inflows are significantly greater than cash outflows
→ Surplus cash could be used to →
→ repay loans
→ purchase non-current assets
→ invest in expansion
→ increase inventory
→ build a cash reserve
→ Evaluation: keeping some cash as a reserve may be sensible → particularly when future cash inflows are uncertain
Amending a Cash Flow Forecast
→ Amending a cash flow forecast → changing the forecast when new or more accurate information becomes available
→ Forecasts may need to be amended because →
→ actual sales differ from estimates
→ customer payments are delayed
→ costs increase
→ unexpected expenses occur
→ suppliers change payment terms
→ planned investment changes
→ Example: A business expected customer receipts of ₹10 lakh in May → customers delay payments → expected receipts are amended to ₹7 lakh
→ This reduces the expected net cash flow → and therefore reduces the closing cash balance
Amending Cash Inflows
→ If expected cash inflows increase → net cash flow increases → closing balance increases
→ If expected cash inflows decrease → net cash flow decreases → closing balance decreases
→ Example:
→ Original inflows = ₹8 lakh
→ Revised inflows = ₹10 lakh
→ Outflows = ₹6 lakh
→ Revised net cash flow = ₹4 lakh
→ Revised closing balance increases by ₹2 lakh
Amending Cash Outflows
→ If expected cash outflows increase → net cash flow decreases → closing balance decreases
→ If expected cash outflows decrease → net cash flow increases → closing balance increases
→ Example:
→ Original outflows = ₹7 lakh
→ Revised outflows = ₹9 lakh
→ Inflows = ₹10 lakh
→ Revised net cash flow = ₹1 lakh
Amending Opening and Closing Balances
→ When one month’s closing balance changes → the following month’s opening balance must also change
→ Example:
→ Original March closing balance = ₹5 lakh
→ Revised March closing balance = ₹3 lakh
→ April opening balance must now be ₹3 lakh, not ₹5 lakh
→ This means → an amendment in one period can affect all subsequent periods
Simple Cash Flow Forecast Example
| ₹ lakh | January | February |
|---|---|---|
| Opening balance | 2 | 4 |
| Cash inflows | 7 | 6 |
| Cash outflows | 5 | 8 |
| Net cash flow | +2 | −2 |
| Closing balance | 4 | 2 |
→ January → ₹2 lakh opening + ₹2 lakh net cash flow = ₹4 lakh closing balance
→ February opening balance → ₹4 lakh, because it equals January’s closing balance
→ February → ₹4 lakh opening − ₹2 lakh net cash flow = ₹2 lakh closing balance
Analysis
→ lower-than-expected cash inflows → lower net cash flow → lower closing balance → possible liquidity problems
→ higher-than-expected cash outflows → lower net cash flow → reduced closing balance → greater need for external finance
→ negative closing balance → business cannot meet expected payments from available cash → overdraft or other finance may be required
→ improving cash inflows or reducing cash outflows → higher net cash flow → improved closing balance → stronger liquidity
→ amendment to one month’s closing balance → changes the next month’s opening balance → may affect the entire remaining forecast
Evaluation
→ Cash flow forecasts are estimates → actual figures may differ because future sales, costs and payment dates are uncertain
→ A forecast should be amended when → new information becomes available
→ A business should not simply reduce important expenditure to improve cash flow → this may damage production, marketing or long-term growth
→ The most appropriate solution to a cash shortage depends on → why the shortage occurred, how long it will last and the financial position of the business
→ Overall → interpreting a cash flow forecast requires managers to understand opening balances, inflows, outflows, net cash flow and closing balances → regular amendment allows the forecast to reflect changing circumstances and helps the business take action before cash-flow problems become serious.