Preparing a Short-Term Cash-Flow Forecast

Short-term cash-flow forecasts are designed to predict your company’s cash flow for periods up to a year. In its final form, your forecast will look much like your receipts-and-disbursements analysis. As with that earlier exercise, the amount of detail you include in the forecasts is up to you and will largely depend on your industry and your own information requirements. Under most conditions, however, a relatively short list of headings, covering primarily those items that are subject to management control, will do.
The best way to prepare short-term cash forecasts is on a rolling monthly basis—that is, the first forecast of the year covers January to December; the next, February to the following Janu¬ary; the next, March through the following February and so on. In that way, you will receive the earliest possible warning of a cash emergency.

Role of Cash-Flow Assumptions
The first step in preparing your forecast is to take a close look at your cash-flow performance for the recent past. A review of the past several months can be most helpful in providing information on items such as inventory levels and accounts receivable.

Next, you must make several broad assumptions about your business for the next year. Is it likely to be a good year, a mediocre year or a bad one? Will costs rise at a faster rate than sales, or vice versa? Many times your assumptions will be wrong, and your forecast will suffer as a result. However, if you set your assumptions down and monitor them continually, you will know when they have fallen short of the mark. As a result, you will be prepared to change your forecast as events unfold.

Once you have made the necessary preparations, you can begin the actual forecasting procedure. As an illustration, refer back to the receipts-and-disbursements analysis for ABC Publishing. The line items on a short-term cash-flow forecast for this company would, in all likelihood, be unchanged from the receipts-and-disbursements analysis. The projection period would, however, extend for an entire year on a monthly basis, rather than over the three months shown in the analysis. Here, on a line-by-line basis, is how you make your short-term cash-flow projections:
● Collections. This is by far the most difficult item in the forecast and unquestionably one of the most critical. Keep in mind that your projections for the earliest one or two months of the forecast are likely to be the most accurate; you have your recent sales results and current accounts-receivable information already on hand.
After the first month or two, your cash budget and past collection experience will be your primary forecasting tools. Whatever the case, if you bring your forecast up to date on a monthly basis, you will always have time to refine your early estimates.
● Cash sales. Your sales forecast and past experience are your primary guides with this category. Although cash sales are not much easier to predict than collections, they are usually not as large and, therefore, not as critical to the forecast.
● Miscellaneous receipts. Recurring items, such as rents, interest and dividends, are simple matters of fact. Nonrecurring items, such as bank loans, are almost always known to manage¬ment in advance.
● Suppliers. Next to collections, this item will probably require the most investigation. You will use primarily your sales forecast and inventory policy to determine supplier payments, but will also factor in production scheduling, purchasing and your accounts-payable policy. Your forecasts for the first few months will be more reliable than those for the future.
● Wages and salaries. This item is usually predictable. The costs of overtime and part-time workers offer the most surprises.
● Overhead. Most of the items are payable on a regular basis, so there should be little difficulty in making a forecast for this category, provided that you remember to take price increases into consideration.
● Financial obligations. These include interest, dividends, taxes and debt repayment. Again, recurring items are known to management, and nonrecurring items are matters of management decision.
● Special items. This category is reserved for one-time decisions, such as the sale of an asset. All such matters involve a management decision and are therefore predictable.

Using a Long-Term Cash-Flow Forecast
There is a fundamental difference between long-term and short-term forecasts. Short-term fore¬casts are tactical and concerned with management control of an existing situation. Long-term forecasts are strategic and designed to assist in development of long-term financing plans that will meet management goals. As a result, forecasting your cash-flow needs for the long term is closely related to strategic planning.

Just as it would be foolish to forecast future cash needs in the absence of specific goals, it would be fruitless to plan a course of action without providing enough cash to get there. In general, your long-term cash forecast should mirror your company’s planning horizon. Always keep in mind that the farther out the plan extends, the less reliable the forecast is likely to be. In our opinion, it is not possible to produce a detailed financial plan for a period longer than three years. Financial markets are too changeable to allow serious planning beyond that.