Define Cash flow forecasting

 Cash flow forecasting or cash flow management is a key aspect of financial management of a business, planning its future cash requirements to avoid a crisis of liquidity.

 Definition

 Cash flow forecasting is the modeling of a company or entity's future financial liquidity over a specific timeframe. Cash usually refers to the company's total bank balances, but often what is forecast is treasury position which is cash plus short-term investments minus short-term debt. Cash flow is the change in cash or treasury position from one period to the next period.

 Cash flow forecasting may be somewhat simpler, planning what cash will come into the business or business unit in order to ensure that outgoing can be managed so as to avoid them exceeding cashflow coming in. Entrepreneurs need to learn fast that "Cash is king" and therefore they must become good at cashflow forecasting.

 Q. Why is cash flow forecasting important? Ans.:

 Cash flow is the life-blood of all businesses, particularly start-ups and small enterprises. If a business runs out of cash and is not able to obtain new finance, it will become insolvent. It is no excuse for management to claim that they didn't see a cash flow crisis coming. So in business, "cash is king". As a result, it is essential that management forecast (predict) what is going to happen to cash flow to make sure the business has enough to survive. Here are the key reasons why a cash flow forecast is so important: Identify potential shortfalls in cash balances in advance - think of the cash flow forecast as an "early warning system". This is, by far, the most important reason for a cash flow forecast. Make sure that the business can afford to pay suppliers and employees. Suppliers who don't get paid will soon stop supplying the business; it is even worse if employees are not paid on time. Spot problems with customer payments - preparing the forecast encourages the business to look at how quickly customers are paying their debts. Note - this is not really a problem for businesses (like retailers) that take most of their sales in cash/credit cards at the point of sale. As an important discipline of financial planning - the cash flow forecast is an important management process, similar to preparing business budgets. External stakeholders such as banks may require a regular forecast. Certainly, if the business has a bank loan, the bank will want to look at the cash flow forecast at regular intervals.

 Q. Describe the Methods of Cash flow forecasting. Ans.:

 The direct method of cash flow forecasting schedules the company's cash receipts and disbursements (R&D). Receipts are primarily the collection of accounts receivable from recent sales, but also include sales of other assets, proceeds of financing, etc. Disbursements include payroll, payment of accounts payable from recent purchases, dividends and interest on debt.

 1) The three indirect methods are based on the company's projected income statements and balance sheets.

 i) The adjusted net income (ANI) method starts with operating income (EBIT or EBITDA) and adds or subtracts changes in balance sheet accounts such as receivables, payables and inventories to project cash flow.

 ii) The pro-forma balance sheet (PBS) method looks straight at the projected book cash account; if all the other balance sheet accounts have been correctly forecast, cash will be correct, too.

 Both the ANI and PBS methods are best suited to the medium-term (up to one year) and long-term (multiple years) forecasting horizons. Both are limited to the monthly or quarterly intervals of the financial plan, and need to be adjusted for the difference between accrual-accounting book cash and the often-significantly-different bank balances.

 iii) The third indirect approach is the accrual reversal method (ARM), which is similar to the ANI method. But instead of using projected balance sheet accounts, large accruals are reversed and cash effects are calculated based upon statistical distributions and algorithms. This allows the forecasting period to be weekly or even daily. It also eliminates the cumulative errors inherent in the direct, R&D method when it is extended beyond the short-term horizon. But because the ARM allocates both accrual reversals and cash effects to weeks or days, it is more complicated than the ANI or PBS indirect methods. The ARM is best suited to the medium-term forecasting horizon.

 2) The simplest method is to have a spreadsheet that shows cash coming in from all sources out to at least 90 days, and all cash going out for the same period. This requires that the quantity and timings of receipts of cash from sales are reasonably accurate, which in turn requires judgment honed by experience of the industry concerned, because it is rare for cash receipts to match sales forecasts exactly, and it is also rare for customers all to pay on time. These principles remain constant whether the cash flow forecasting is done on a spreadsheet or on paper or on some other IT system.

 Management Amounting-Cash Flow foreoesting

 Q.Illustrate the Uses of Cash flow forecasting. Ans.:

 Uses of Cash flow forecasting:

 1) The point of making the forecast of incoming cash is to manage the outflow of cash so that the business remains solvent.

 2) A cash flow projection is an important input into valuation of assets, budgeting and determining appropriate capital structures in LBOs and leveraged recapitalizations.

 Q.Write in brief about the Uses of Cash flow forecasting. Ans.:

 A danger of using too much corporate finance theoretical methods in cash flow forecasting for managing a business is that there can be non cash items in the cashflow as reported under financial accounting standards. This goes to the heart of the difference between financial accounting and management accounting.

 Ch-Cash Flow statement

 

Problem-1: Presented below is the comparative balance sheet for Navana Corporation as of Oct, 3 I^s' :­

Assets

Particulars	2012 Taka	2011 Taka
Cash	41,000	45,000
Account receivable	47,500	52,000
Inventory	1,51,450	1,42,000
Prepaid expenses	16,780	21,000
Land	1,00,000	1,30,000
Equipment	2,28,000	1,55,000
Accumulated depreciation-equipment	(45,000)	(35,000)
Building	2,00,000	2,00,000
Accumulated depreciation-building	_ (60,000)	(40,000)
	6,79,730	6,70,000

 

Liabilities and stockholders' Equity

Particulars	2012           ~ Taka	2011 Taka
Accounts payable	43,730	40,000
Bonds payable	2,50,000	3,00,000
Common Stock, Tk. 10 par	2,00,000	1,50,000
Retained Earnings	1,86,000	1,80,000
	6,79,730	6,70,000

 

Additional information:

(1) Operating expenses include depreciation expense of Tk. 42,000 and charges from

prepaid expenses of Tk. 4,220;

(2) Land was sold for cash at book value;

(3) Cash dividends of Tk. 32,000 were paid;

(4) Net income for the year was Tk. 38,000;

(5) Equipment was purchased for Tk. 95,000 cash. In addition, equipment costing Tk. 22,000 with a book value of Tk. 10,000 was sold for Tk. 8,100 cash.

(6) Bonds were converted at face value by issuing 5,000 shares of Tk.10 par value common stock.

Instructions: Prepare a statement of Cash flow for the year ended October, 31,2012, using the indirect method.

Net Cash flow from financing activities		(32.000)

 

Indirect Method :

 

Particulars	Taka	Taka
(A) Cash flow from operating activities:
Net Income	38,000
Adjustment to reconcile net income to net cash provided by operating activities:
Decrease in account re eivable	4,500
Increase in inventories
Increase in account pa able
Decrease in prepaid ex crises	4,220
Depreciation expenses	42,000
Capital (Loss on )sale of assets	1 900
Net Cash provided by operating activities		84,900
(B) Cash flow from investing activities:
Purchase of plants and assets:
Sales of land	30,000
Purchase of equipment	(95,000)
Sales of equipment	8,100
Net Cash flow from investing activities		(56.900)
(C) Cash flow from financing activities:
Decrease in bonds payable	(50,000)
Proceed from stock issue	50,000
Paid cash dividend	(32,000)
Change in cash		(4,000)
Opening cash balance in 2010		41,000
-Closing cash balance at 31s' October, 2010		37000

 

Statement of Cost

 

Problem-1 (Nov.11) : A factory produced and sold 1,000 units of product in the month of June,

2012 for which the following particulars are available: Particulars	Taka
Stock of Raw Materials on I 't June	6,000
Purchase and receipt of Raw Materials during the month of June	1,44,000
Direct wages paid in cash in June(which included Tk. 3,000 on	55,000
account of May and Tk. 2,000 advance for July) Stock of Raw Materials on 30`" June	10,000
Works overhead charges for the month	60,000
Administrative and selling overheads	Tk. 25 per unit
Sales price	Tk. 300 per unit
From the above particulars you are required to prepare:

 

1. A statement of cost for the month of June,2012;

2. Estimate the sales price of a unit of the same product in July, 2012, assuming­(i) 10% increase in the cost of raw materials;

(ii) 10% increase in the direct wages:

(iii) 5% increase in works overhead charges;

(iv) 20% decrease in administrative and selling overhead charges;

(v) Same percentage of profit on sales price as earned during the month of June.

Solution:

1) Statement of cost for the month of June, 2012-

f Particulars		Taka	Taka
Opening stock of RM (1 s` June)			6,000
Add-Purchase and receipt of RM during the month of June			1,44,000
Add- Direct wages		55,000-(3,000+2000)	50,000
Add-Works overhead charges for the month			60,000
Add-Administrative and selling overheads		1000 units x Tk. 25 per unit	25,000
2,85,000
Clsing stock of RM			10,000
Cost of Goods sold			2,75,000
Sales price Tk. 300 per unit
Sales proceed	(Tk. 300 1000 units)		3,00,000
Profit	Tk. 3,00,000-Tk. 2,75,000		25,000
Percentage of profit on sales	Tk. (25,OOOx 100)/3,00,000		8.33%

 

 

2) Estimatiniz the sales price:	1,44,000 14,400 1,58,400
(i) RM purchased Add-10% increase
(ii) Direct wages	50,000
10% increase	5,000
	55,000
(iii) Works overhead	60,000
5% increase	3,000
	63,000
(iv) Administrative and selling expenses	25,000
20% decrease	5,000
	20,000

 

c) Statement of cost (revised)

_Particulars		Taka	Taka
_Opening stock of RM			6,000
Add-Purchase and recei. of RM			1,58,400
			1,64,400
Clsing stock of RM -			(10,000)
_RM_consumed			1,54,400
_Add- Direct wages			55,000
~ Add-Works overhead charges for the month --- -			63,000 20,000
Add-Administrative and selling overheads
Cost of Goods sold			2,92,400
Add-Profit margin 8.33% (as on June)=2,92,400X8.33%			24,356.92
Sales proceed			3,16,756.92
[Sales_price of a unit	Tk. 3,16,756.92/1000 units		__ 316.76