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中文A cash flow forecast should show how much money you expect to be flowing into and out of your bank account and when. It must show that the business will have enough access to money to survive over short and long term periods. For a new business proposal to be considered feasible a cash flow statement must be as accurate as possible and the source of funding must be identified. As a business becomes more established, its cash flow statement will become more predictable but it is highly unlikely that it will ever be 100% correct. The importance of a business managing its cash flow can not be underestimated. Businesses can have strong results in terms of profits but at the same time have shortfall of cash that can result in major problems (Gowthorpe, 2005). A business plan needs to include a cash flow forecast so that the number of sales needed for the business to succeed is known. The profit and loss account and the balance sheet show how things stand financially for the business at that specific point in time (a snapshot) and can be used as a measurement to see if the business is achieving its sales targets. A business needs cash to pay its employees, to buy new non-current assets, to settle claims against the business, etc. A new business proposal must include a minimum amount of cash flow that the business needs to survive. ‘What if’ scenarios are common practice for businesses when producing cash flow forecasts to see what the effect on the company if sales are up and down by percentages given expected profit margins. McLaney and Atrill (2004) claim the main underlying reason a business goes ‘under’ is because they are unable to find the amount of cash they owe.
There are three main parts to a cash flow forecast:
1. Operating activities
2. Investing activities
3. Financing activities
In terms of operating activities, these are the main source of a company’s profits which include any cash transaction in the day to day running of the business, such as cash from the sale of a product. Other examples of operating activities include the inputting of credit receipts, interest, refunds paid, payment to employees, suppliers and additional financing costs (Van Horne & Wachowicz, 2001).
‘Investing activities,’ include any sale or purchase of a non-current asset the company has made such as property, plant and equipment, stock, bonds and securities, as well as covering any purchase of intangibles. The business overheads need to be assessed and the timing of the payments for these (wages, rent, rates, utilities, insurance, pensions etc.). Payment of VAT, PAYE and NI need to be assessed as these have specific payment dates and are determined by the success of the business. Wages and rent are one of the most inflexible overheads in that they will not vary too much on a month-to-month basis. Over time, the business will be able to review how it has used any cash that has been generated by the business through various accounting ratios.
The final part of a cash flow statement includes any borrowing repayments the business has made and also states the amount of money that has been used to issue stock and pay dividends. In addition, this can include any further working capital (working capital = current assets – current liabilities) that the owners/partners have put in to the business (White et al, 1997).
When looking at a cash flow statement, the first thing analysed will be the operating activities. The amount of income that will be generated from sales is important but if the business has high expenditure from various overheads then it will be a concern for potential investors. A cash flow forecast allows creditors to assess the risk exposure of the business before a lending decision or investment is made. Bernstein and Wild (1999) claim that managerial strategies of a company can be reviewed to adapt to ever-changing business environments from the analysis of a cash flow forecast. Initially, the cash flow forecast allows strategies to be put in place before the company begins to trade. The forecast will show how much cash the business will generate on a daily basis and how much of that can be used if emergency funds need to be available. It can also help to prove how a business is going to pay back investors as well as covering the operational costs. Should the business proposal include a five year prediction of its cash flow, an ‘adequacy’ ratio can be calculated to help measure the company’s ability to do this (Total cash from five year sum or operations/Five year sum of capital expenditures, inventory additions and cash dividends). However, a cash flow forecast is just a prediction, the level and the uncertainty of the sales forecasts must be taken into consideration and can have an impact on the overall feasibility of the proposal (Bernstein & Wild, 1999). In addition, the source of a company’s financing is significant because it makes it easier to assess the level of risk involved and how solvent the business is and gives accountants a better idea of the capital structure. A cash flow forecast helps to identify the sources of financing and helps illustrate the level of earning power a business is likely to have over certain periods of time and the amount of cash it is able to generate from its operational activities. This is obviously crucial in the decision process with regard to deciding on the feasibility of a proposal. It is important to point out that the longer the forecast, the more uncertain the figures are likely to be due to a number of external factors such as general market conditions, government and regulation etc. Many assumptions have to be made based on current circumstances and what will happen in the future (Bragg, 2006).
Depending on what happens at the point of sale (whether or not cash changes hands or alternatively the sale is made on credit), the wealth of the business will be affected. Should cash exchange hands then this may lead to an increase in wealth that will be reflected on the profit and loss account. On the other hand, if no cash is exchanged at the point of sale, the wealth is shown in another asset such as ‘trade debtors.’ In addition, wealth is lost due to a reduction in stock. This will be shown as an expense on the profit and loss account (see appendix 2) (McLaney & Atrill, 2004). Using a percentage as a profit margin you can calculate a break even point for the business. E.G. if there is a 25% profit margin then you will need four times the amount of fixed costs in sales to breakeven. Forecasts need to state key assumptions (prices, sales volumes, timing). This is an example of where the three main financial statements can be related. In addition, as shown in appendix 2, the figures taken in the profit and loss account from the cash flow are the final figures for the year end period but not all are taken in to account. For example, depreciation is not included in a cash flow forecast, therefore a cash flow forecast does not necessarily give a true picture of the investment initially as over time, the business will have to replace its equipment (assets). The balance sheet is merely a snapshot of the business’s financial position and shows the working capital requirement (current assets less current liabilities). However, this can also be worked out more accurately from the cash flow forecast. The balance sheet is useful for working out a number of ratios to maintain effective financial control, such as the total capital employed (Barrow et al, 2005). However, a cash flow forecast can be used to track specific movements of cash where the balance sheet and profit and loss account can not.
Although a cash flow forecast provides many answers for a new business proposal, there are other sources of financial information that can be used which is not illustrated on a cash flow statement. The new proposal could involve what is known as ‘security’ to help finance the business. Such examples of security can include personal savings, property or anything of significant value that can be guaranteed and used as collateral. Business owners must convince the financier that by providing the finance will result in cash flows enabling them to get a high rate of return on their investment (DeThomas & Derammelaere, 2008). Ratio’s can be worked out from the cash flow forecast to determine the liquidity and profitability of the company. The competition in the market, consumer demand, supplier costs and the proposed company’s product quality itself are additional factors that contribute to the feasibility of the new business proposal. For example, should the potential of the new business to be able to capture a large share of the market, the risk will not be as high for investors as it may appear. In addition, interest rates can have a significant impact on a company’s financial status and eat in to profits which must also be accounted for (another reason why ‘what if’ scenarios are required). Although a company may be unbiased when forecasting its sales, differences in uncertainty must be recognized and sales targets realistic (Bernstein & Wild, 1999).
Based on the information and data provided, we can conclude that the cash flow forecast plays a major part in proving a new business proposal’s feasibility, but there are a number of risks that must be evaluated along with additional financial information that can be used to help support the proposal. These include forecasting the income and expenditure of the business (summarised in a profit and loss account forecast), depreciation that can have a significant impact on a company’s expenditure, changes in interest rates as well as additional influences explained earlier. There will always be a degree of uncertainty toward the accuracy of figures shown in a cash flow forecast for new business proposals, there are only so many figures and assumptions that a new proposal can produce in order to be considered achievable. There will always be the challenge of developing a successful business and exceeding the targets set in the dynamic business environment. The description in each of the appendices helps to explain in more detail how financial statements can be related and some of the difficulties in determining a proposal’s feasibility. I could go in to greater detail regarding alternative methods of dealing with uncertainty such as sensitivity and probability analysis as described by Graham & Coyle (2000) as well as key ratios but due to the word constraints I am unable to do so.
An example of a cash flow forecast for company X on a monthly basis for the course of a one year. The majority of the figures are difficult to predict although a few shown are constant such as advertising, loan repayments and interest. Some figures are likely to be different due to the frequency of payments (e.g. water/gas/electric maybe paid quarterly). This demonstrates the difficulty in predicting such figures when developing a proposal and therefore makes it difficult to decide its feasibility.
This is company X’s profit and loss account. The total overheads for the year end are carried over from the cash flow forecast to help calculate the company’s operating profit. Also included is the amount of money the business will retain and plough back in to the company for various things such as equipment. With depreciation taken in to account, it would extremely useful in helping to prove the feasibility of a project it should this figure be known.
This is the balance sheet for company X. The balance sheet is merely a snapshot of the businesses financial position and shows the working capital requirement of the business (current assets less current liabilities). The balance sheet is useful for working out a number of ratios to maintain effective financial control, such as the total capital employed (Barrow et al, 2005). Whilst this data is extremely useful once the business is operating, it is very difficult to use the balance sheet toward proving a project’s feasibility without accurate data.
