FREE online courses on How to Manage Cash Flow - Chapter 2 - Cash Flow Forecasting

 

One of the best ways to determine the optimal cash balance is to fully understand cash flow patterns. This requires that we plot cash flows and prepare a forecast. A cash flow forecast gives us a detail projection of future cash inflows and outflows. This will help us avoid cash deficiencies as well as excessive cash balances. A cash flow forecast also answers several questions, such as how long can we invest idle cash, when will it be necessary to borrow cash, and when can we purchase new capital assets? A typical cash flow forecast will include: Cash on Hand, Expected Receipts, and Expected Disbursements. Each major receipt and disbursement should be listed as a separate line item. Example 7 illustrates a basic cash flow forecast.

 

Example 7 -  Monthly Cash Flow Forecast

                                                          January

Beginning Cash on Hand                $      60

Operating Receipts:                             

 Accounts Receivable                              1,200

 Other Receipts                                     - 0 -

Operating Disbursements:

          Payroll                                       ( 850)

          Taxes                                        (   35)

          Utilities                                      (    80)

          Insurance                                   (  110)

          Supplies                                     (    60)

          Services                                     (  350)

 Other                                                 (    40)

Net Operating Cash Flow                         $( 325)

Investment Receipts:

          Investment Income                      - 0 -

          Sale of Marketable Securities         - 0 -

          Sale of Assets                                       - 0 -

Investment Disbursements:

          Invest in Marketable Securities       - 0 -

          Invest in Capital Assets                 - 0 -

Financing Receipts:

          Proceeds from Loans                     - 0 -

          Proceeds from Asset Borrowings      - 0 -

Financing Disbursements:

          Repay Loans & Debt                     - 0 -

Net Change in Cash                                $(325)

Total Available Cash                               (  265)

Minimum Cash Balance                                 40

Surplus (Deficit)                                      ( 305)

Activate Line of Credit                                 325

Ending Cash Balance                               $     60

 

The overall objective is to prepare a cash flow forecast that is accurate enough to determine cash sufficiency. As a general rule, it is more difficult to predict cash receipts than cash disbursements. When making estimates about receipts and disbursements, consider using expected values, especially if you are uncertain about final amounts.  Example 8 illustrates the calculation of expected values for cash receipts from three service contracts.

 

 

Example 8 --- Calculate the Expected Value of Receipts

 

Customer	Sales Contract	Probability of Getting Contract	Expected Value
Ashcroft	$ 10,000	20%	$ 2,000
Carson	$ 15,000	50%	$ 7,500
Franklin	$ 8,000	80%	$ 6,400
		Total Expected Value	$15,900

 

One way to predict customer receipts is to simply plot your collection patterns. Example 9 summarizes collection patterns based on past sales collections.

 

Example 9 --- Plot Historical Collection %'s

 

Sales Month	0 – 30 Days	31-60 Days	61-90 Days	91-120 Days	Over 121 Days	Total %
January	15%	38%	40%	6%	1%	100%
February	14%	42%	39%	4%	1%	100%
March	14%	41%	39%	5%	1%	100%
April	12%	46%	36%	5%	1%	100%

 

Finally, consider the following points when preparing cash flow forecasts:

 

·         Prepare cash forecasts for shorter periods of time (weekly or daily) if cash flows are tight.

·         Use available data as much as possible to prepare cash flow forecasts.

·         If necessary, prepare two forecasts: Early Warning Forecast for longer periods of time (six months) and Targeted Forecast for shorter periods of time (weekly).

·         Be advised that cash flow forecasting is extremely difficult in periods of rapid growth.

§         Special Bank Accounts

§

One method for maintaining an optimal cash balance is to use Zero Balance Accounts,  Sweep Accounts, and Investment Accounts. These accounts will automatically invest surplus cash while still serving as your main transaction account. Disbursements are cleared through a special account which has just enough cash to cover all transactions. The Bank makes a "sweep" of the account and takes any surplus cash and places it into a money market account. Money market accounts are one of the most popular accounts for investing surplus cash. Brokerage houses also offer investment accounts which sometimes earn slightly higher rates than money market accounts. When deciding which types of accounts to use, consider the following guidelines:

 

·         If your average daily surplus cash exceeds $ 500,000, setup a direct overnight investment program with a brokerage house.

·         If your average daily surplus cash exceeds $ 50,000, but is well below $ 500,000, setup a sweep account with your bank.

·         If your average daily surplus cash is below $ 50,000, consider using a regular investment account with a brokerage house.