Cash Flow Forecasting

Transcription

1 Cash Flow Forecasting

2 What this topic is all about Cash flow is a dynamic and unpredictable part of life for a start up Cash flow problems are the main reason why a new business fails Cash flow forecasting looks at why and how a start up should prepare regular forecasts

3 Why cash flow forecasting is important Cash is king it is the lifeblood of a business If a business runs out of cash it will almost certainly fail Few start ups have unlimited finance cash is limited, so it needs to be managed carefully

4 Reasons to produce a cash flow forecast Identify potential shortfalls in cash balances in advance (important) Make sure that the business can afford to pay suppliers and employees Spot problems with customer payments As an important part of financial control Provide reassurance to investors and lenders that the business is being managed properly

5 Why start ups are vulnerable to cash flow problems It can be a while before the business makes its first sales the pre trading period often involves incurring costs without getting any revenue in return Suppliers may demand immediate or early payment from the start up as the business has not developed a track record for paying bills on time A new business usually has to spend up front on expenses such as marketing and product development The new business will not have reserves of cash built up from profitable trading an important source of cash known as retained profits

6 Sources of information for a cash flow forecast Entrepreneur experience Industry experience can prove vital Otherwise, it forecast has to include gut feel assumptions (dangerous) Market research A crucial role typical payment terms for customers, suppliers Reflect seasonal peaks and troughs in demand Helps identify potential costs Suppliers Very useful source of industry information Advisers Great for helping put the forecast together Can challenge the assumptions made Can check that the forecast is complete and accurate

7 What the cash flow forecast contains Cash inflows (into the business) Movements of cash into the bank Receipts from customers Investment by the entrepreneur Loans from the bank or others Cash outflows (out of the business) Payments to suppliers (materials, equipment, premises) Payments to employees (wages & salaries) Payments to lenders (e.g. interest, loan repayments) Payments to shareholders (dividends)

8 Cash flow forecast illustrated Jan Feb Mar Total CASH INFLOWS Investment 10,000 10,000 Sales 2,500 10,000 15,000 27,500 Total inflows 12,500 10,000 15,000 37,500 CASH OUTFLOWS Raw materials 4,000 5,000 5,000 14,000 Wages & salaries 3,500 4,000 4,000 11,500 Marketing 2,500 1,000 2,000 5,500 Set-up costs 3,000 1, ,000 Other costs 2,000 1,000 1,000 4,000 Total outflows 15,000 12,000 12,000 39,000 NET CASH FLOW -2,500-2,000 3,000-1,500 Opening balance 0-2,500-4,500 Closing balance -2,500-4,500-1,500 Forecast is normally produced by month Net cash flow is the difference each month between cash inflows and cash outflows Opening balance is the amount the business starts with each month Closing balance = opening balance + net cash flow Negative closing balance suggests business needs bank overdraft or additional financing

9 Common problems with cash flow forecasts Sales prove lower than expected Easy to be over optimistic about sales potential Market research may have gaps Customers do not pay up on time A notorious problem for small businesses The cost of production proves higher than expected Perhaps because purchase prices turn out higher Maybe also because the business is inefficient Certain costs are not included A common problem for a start up Unexpected costs always arise often significant

10 Responding to the limitations Given the limitations of cash flow forecasting outlined above, how should an entrepreneur respond? A good way is to create two different versions of the cash flow forecast: A base case version which is the expected or hoped for version A downside or worst case version, which takes a pessimistic view of what might happen Which forecast should be used? It depends on who is reading it. The bank manager is probably best given the downside version so that his/her expectations are managed

11 Exam Tips You cannot underestimate the importance of cash flow forecasting for a start up. Think of the cash flow forecast as the "early warning system", which will show when the danger periods are and how viable the business is Don't forget that cash flow forecasts are not perfect they have their limitations, not the least because they are based on estimates and assumptions. It is important for the entrepreneur to think about the different scenarios that might arise this is known as "what if" analysis. The "worst case" scenario is always worth assessing to see what might happen if things do go badly wrong! It is really important to understand that cash flow is not the same as profit. A business can be profitable, but suffer from cash outflows if customers don't pay their debts or suppliers need paying early. Don't forget to make the links with other parts of the BUSS1 course. For example, the use of market research can help improve the accuracy and reliability of cash flow assumptions. The cash flow forecast should also be consistent with the choices made about sources of finance. There is no point assuming the use of a bank overdraft if the bank will not provide the overdraft facility.

12 Cash Flow Forecasting