Adapt Flow-of-Funds Analysis

Adapt Flow-of-Funds Analysis
Just as the receipts-and-disbursements analysis provided a framework for a short-term cash forecast, the flow-of-funds analysis technique can be adapted to long-term forecasting. However, unlike the short-term forecast, some changes in the format used for the flow-of-funds analysis are necessary to separate the impact of operational and financial decisions.

Illustration: Take a look at the table on page 50, where we have used the information contained in the cash budget for ABC Publishing Company as the basis for a long-term cash forecast. We have also assumed that, as in the flow-of-funds analysis, ABC Publishing decreased inventories by $2,000 and raised accounts receivable by the same amount. In addition, the company purchased a binding machine for $10,000 on credit.

Obviously, this forecast is behind the times. In the real world, the forecast could have been made well before a cash budget was submitted and would extend out for three years or more. Nevertheless, it does demonstrate how closely a long-term forecast parallels a flow-of-funds analysis, while at the same time adding information that long-term planners would need to make intelligent decisions. In ABC’s case, no financial surprises are in store. Operating cash makes up more than half of the cash needed to meet obligations. The balance of the needed cash is easily met by a short-term loan and new credit.

Normally, long-term cash fore-casts are updated annually as man-agement reviews strategic plans and draws up new budgets. Therefore, even if the plan were a bit wide of the mark, ABC would have time to revise it in subsequent years. Remember that the first year of a long-term plan must always conform to forecasts made in the short-term plan. Otherwise, man-agers may find themselves at cross purposes with one another.

Following are the major categories of information in a long-term forecast:
● Cash flow from operations. This category is usually part of your strategic plan. As cash flow, this item is before interest, taxes and depreciation.
● Taxes. This is a fairly straightfor¬ward item, but don’t overlook possible tax savings in the future.
● Fixed assets (land, buildings, plant and equipment). Payments due for the purchase of new as¬sets are usually found in the com-pany’s capital budget. Don’t forget the various costs associated with these assets, such as maintenance and routine administrative activi¬ties.
● Noncash current assets. These include inventories and accounts receivable. Inventory and credit
policies do not change often, so you can usually apply past experience to sales projections for future years to obtain reasonable estimates for changes in inventory and/or accounts receivable.
● Financial obligations (interest, dividends, repayment of loans or bonds). It should be simple to forecast payments due on current obligations, but you may find it difficult to project inter-est and principal payments on future loans. Dividends are not mandatory, but for the sake of clarity, you should include them.
● Net cash requirements. If there is to be a cash surplus in your firm’s future, you will first identify it here. Rather than a net cash requirement, you will come up with a net surplus. You can, of course, make plans to increase your dividends or to invest the surplus for a while.
● Available cash. This reflects drawings from both existing cash balances and cash equivalents (U.S. Treasury bills, certificates of deposit, etc.). A surplus to be invested would be treated as a negative item on this line.

● New credit. Planned purchases, such as the $10,000 binding machine cited in the illustration, are rather easy to identify. However, you may have to look closely to spot a possible need for additional extensions of credit with suppliers.
● New sources of capital. These final items are strictly the result of management decisions. They are the “balancing items” but also represent the end result of your firm’s financial strategy.

Keeping Cash Flow Under Control
As you compile your cash forecasts, be they short or long term in nature, you are forced to come to grips with possible cash-flow problems. No sensible forecast would leave a potentially harmful cash-flow problem untouched. Your analyses of receipts and disbursements and of the flow of funds will allow you to make any necessary adjustments to bring the forecasts in line with reality. The final information tool in the system is a monthly liquidity report, which is easily prepared from monthly statements and previous forecasts. It gives you the information necessary to make day-to-day working decisions concerning your cash flow.

Illustration: Preparing a liquidity report is more a matter of organizing your existing information rather than gathering new data. All the information needed for the report should be readily available shortly after the end of each month. For details on how your liquidity report might look, see the box below.


Balance—End of Month Forecast Actual Change Coming Month
Cash on Hand and in Bank
Cash Equivalents
(Short‑Term Investments)
Accounts Receivable
Accounts Payable
Inventories
Unused Lines of Credit