by OverHeadWatch Team | May 11, 2017 | Budget Planning, Library
An accurate cash flow forecast is important to a business since business operations and valuations make a distinction between total assets and liquid assets such as cash. Cash flow needs to meet near-term obligations such as payroll, debt payments, purchases, and the like. A business may have a great strategy and even growth. But if all profits are re-invested into equity and assets, situations requiring immediate cash will squeeze it into a corner. The business will have to respond to a cash shortage by:
- Adding on extra debt;
- Selling assets that could be used for future growth;
- Selling additional business equity that forms the backbone of a business owner’s wealth creation.
Given these facts, it is important to know:
- The components and limitations of cash flow forecasts;
- Investment in man-hours and expertise needed to produce accurate cash flow forecasts;
- The use of cash flow forecasts in business operations.
What Is a Cash Flow Forecast?
A cash flow forecast provides a useful guide to the amount and timing of liquid cash and cash-equivalents in the near future. Typically, cash flow projections have an upper limit of 12 months into the future and regularly asks for an update. Long forecasts become meaningless as the business environment has a larger chance of changing in unforeseen ways over longer timescales.
Cash flow projections are limited not only in how far into the future they are useful, but also on the other extreme. Frequent forecasts are redundant since they should cover day-to-day operational expertise and AR/AP accounting.
Who Needs a Cash Flow Forecast the Most?
All businesses could benefit from a reliable cash flow forecast. But those with a relatively steady and diverse customer base are in the best position to allocate manpower to cash flow projections. The reason for this bias towards steady businesses has to do with the higher degree and uncertainty of business-customer relations that characterize many new entrepreneurial ventures.
Start-ups and some small businesses can and may need to alter their core competencies, operations, sales strategies and financial situation too quickly for a forecast to be meaningful on a relevant timescale.
How Much is Usually Spent on Cash Flow Forecasts?
Cash flow forecasts are the domain of accounting specialists, financial reporting professionals, and management that reports to the CFO or an equivalent executive company leader. Each company will have its own approach to handling cash flow projections. This is because of different assumptions and timelines they use as well as the informal corporate culture that influences what goes up and down the chain of command. Those and similar variables make it difficult to quantify how much manpower is necessary for cash flow forecasts.
Nonetheless, it’s safe to say that a company should invest enough in cash flow estimates to incorporate a feedback loop. This comes from regularly updated sales performance, assets/liabilities and customer relations to cash flow projections. Management should examine and, when necessary, update the cash flow forecast template that a company uses. This will contain new information in market/industry trends, tax, and regulatory changes.
4 Ways You Can Reduce Cash Flow Forecast Opportunity Cost
Though the guidance here is unavoidably general, companies from many market sectors could benefit from the below.
- Conducting a study of past cash flow forecast accuracy for the past 5-15 years. This should provide some clue as to which personnel, forecasting styles, assumptions or institutional culture led to more accurate predictions.
- Designating certain personnel responsible for cash flow forecasts and, within reason, rewarding them accordingly for accuracy. Within reason pertains to identifiable external factors that can confound even the best research and forecasts. Blaming or rewarding cash flow forecast personnel for being in or out of alignment with external economic factors is, of course, irrational and harmful to company culture.
- Research similar businesses and, if possible, glean cash flow information from their financial reporting. Examine any correlation between cash flow amounts/trends and overall business success.
- Prioritize company assets and have a plan that, if cash flow turns unexpectedly low, sell easy-to-replace low-priority assets.
It’s tempting to reduce the time and effort spent on cash flow forecasts in favor of here and now priorities. On the other hand, there is also grand, long-term growth plans on the other. However, the importance of cash flow to near-term investor confidence and smooth business operations is hard to overstate.
- Without sufficient cash, an otherwise-successful business may have to sell precious assets, equity, or debt. That could cause far more harm than good in the long term.
- With excessive cash, the decision of how to invest the excess can eat up lots of time. It may also lead to impulsive decisions and dissent within the ranks of management.
Given these facts, reducing the manpower you can spend on estimating cash flow is not an action you should do hastily.
Conclusion
Business owners and decision makers can think of cash flow forecasts and cash flow itself as an insurance that increases the odds of future growth. The opportunity cost of focusing on cash flow forecasts and cash itself can just sit around. Or it can be put to high-return ventures and compensate through flexibility and short-term liquidity that can enhance or damage a company’s reputation.
After all, a company that has trouble paying its employees, vendors or creditors because of short-term cash shortage is struggling. This is even if, from a profit margin and balance sheet perspective, it is successful. Cash flow forecasting should not be an obsessive concern for managers and owners. But it should be pretty high on the priority list when it comes to management duties that ensure smooth business operations up to a year into the future. Managers, business owners, investors and others can provide their input through Facebook or the comments section.
The images are from pixabay.com.
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