Cash flow forecasts

Cash flow forecasts (AO2, AO4)

Cash flow refers to the movement of money in and out of an organization. Cash flow forecasting is a quantitative technique used by business managers to predict how cash is likely to flow into and out of the organization for a particular period of time, such as for the next twelve months.

Cash flow forecasting is a management tool used to monitor an organization’s cash flows in order to avoid liquidity problems. Knowing in advance when the business is likely to face a period of cash shortages (or a liquidity problem) can help it to plan accordingly so that it can continue to operate.

A liquidity problem occurs when there is a lack of cash in the organization because its cash inflow is less than its cash outflow, i.e. it experiences negative net cash flow.

Examples of cash inflows include:

  • Cash used by customers to pay for the sale of goods and services
  • Bank overdrafts and/or bank loans
  • Capital injections from the owners of the business
  • Payments made to the business from its debtors
  • Government grants and/or subsidies
  • Cash injection from sponsors.

Examples of cash outflows include payments for:

  • Rent of premises
  • Purchasing raw materials
  • Staff wages, salaries and perks (benefits)
  • Utility bills, e.g. gas, water, electricity, internet and telephone bills
  • Insurance.
Net cash flow (NCF) is the numerical difference between an organization’s total cash inflows and its total cash outflows, per time period.

Net Cash Flow = Cash inflows – Cash outflows

A positive net cash flow exists if the total cash inflows are greater than the total cash outflows for a given period of time, such as a month or per quarter. A negative net cash flow exists if the total outflows exceed the total inflows for particular time period.

Being able to predict cash flow helps a business with its financial management and decision-making.

Key terms

Cash flow is the movement of money in and out of an organization for a particular period of time, such as for the next six months.

Cash flow forecasting is a business management tool used to monitor an organization’s cash flows so that it can operate without liquidity problems.

A liquidity problem occurs when an business has negative net cash flow, i.e. a lack of cash as the firm's cash outflows exceed its cash inflows.

Net cash flow (NCF) refers to an organization’s estimated difference between its monthly cash inflows and cash outflows.

    Exam practice question 1

    Explain two reasons why a new bakery business is likely to face liquidity problems in its first few months of operation.     [4 marks]

    Possible reasons include a combination of why cash outflows for the bakery business are likely to exceed cash inflows:

    • A lack of marketing exposure to create sufficient sales revenue at the bakery
    • Inability to attract customers away from well-established supermarkets that provide bakery products
    • High set-up costs which will take several months (at least) to recover once the bakery is operational
    • Ongoing expenses (such as salaries and rent) may initially exceed cash inflows from new customers.

    Mark as a 2 + 2

    Calculating cash flow forecasts

    To calculate cash flows for each time period, the following are needed:

    • Opening balance
    • Net cash flow
    • Closing balance

    The opening balance in a cash flow forecast refers to the value of cash held by a business at the start of a trading period (usually the beginning of the month).

    Net cash flow is the numerical difference between an organization’s total cash inflows and its total cash outflows, per time period.

    The closing balance in a cash flow forecast refers to the value of cash held by a business at the end of a trading period (usually the final day of the month), which therefore becomes the opening balance for the next time period.

    Closing balance = Opening balance + Net cash flow

    Cash flow forecasting formulae

    Net cash flow                =     Total cash inflow – Total cash outflow

    Closing balance            =     Opening balance + Net cash flow

    Opening balance          =     Closing balance in previous month

    Top tip!

    Remember that a cash flow forecast (CFF) is different from a cash flow statement (CFS). A CFF is a prediction of the cash flows in and out of a business over the foreseeable future. The CFS shows the actual cash inflows and outflows for a specified time period.

    Exam practice question 2

    The chief accountant of 360 Computers has compiled the following financial data: opening balance = $50,000, total cash outflows = $120,000, and total cash inflows = $110,000.

    Calculate the closing balance for 360 Computers.   [2 marks]

    Net cash flow = $110,000 minus $120,000 = ($10,000)

    Closing balance = $50,000 + ($10,000) = $40,000

    Award 1 mark for showing the working out.

    Award 1 mark for the correct answer, i.e. $40,000.

    Exam practice question 3

    Ortega Football Academy’s cash flow forecast shows a closing balance of $80,000 at the end of this month. Carlos, the finance director, then discovers that debtors of $12,000 have yet to be included and there is an outstanding invoice of $18,000 that needs to be paid. Calculate the closing balance for Ortega Football Academy.          [2 marks]

    Answer

    Ortega Football Academy’s closing balance = $80,000 + $12,000 – $18,000 = $74,000

    Award 1 mark for showing the working out.

    Award 1 mark for the correct answer, i.e. $74,000.

    Exam practice question 4

    Refer to the figures below for excerpts from Tonina & Co.’s cash flow statement.

                Opening balance:   $135,500

                Cash inflow:            $532,500

                Cash outflow:          $352,500

    a.  Define the term cash flow statement.                       [2 marks]

    A cash flow statement shows the actual cash inflows and outflows of an organization for a specified time period.

    b.  Calculate Tonina & Co.’s net cash flow.                     [2 marks]

    Net cash flow = Cash inflow – Cash outflow

    NCF = $532,500 – $352,500 = $180,000

    Award 1 mark for the correct answer

    Award 1 mark for appropriate working out.

    c.  Calculate Tonina & Co.’s closing balance.                 [2 marks]

    Closing balance = Opening balance + Net cash flow

    Closing balance = $135,500 + $180,000 = $315,500

    Award 1 mark for the correct answer

    Award 1 mark for appropriate working out.

    Exam practice question 5

    Complete the 3-month cash flow forecast for Mustang & Ford Winery.       [4 marks]

    Dec ($)

    Jan ($)

    Feb ($)

    Sales revenue

    8,500

    7,500

    Bank loan

    0

    4,000

    Cash inflow

    10,500

    7,500

    Cost of goods sold

    5100

    3900

    4500

    Salaries

    2000

    2000

    2000

    Rent

    1800

    1800

    1800

    Other costs

    300

    400

    Cash outflow

    9,280

    8,000

    Net cash flow

    -780

    -1,200

    Opening balance

    0

    -780

    1,720

    Closing balance

    1,720

    520

    Answer

    Cash flow forecast for Mustang & Ford Winery:

    Dec ($)

    Jan ($)

    Feb ($)

    Sales revenue

    8,500

    6,500

    7,500

    Bank loan

    0

    4,000

    0

    Cash inflow

    8,500

    10,500

    7,500

    Cost of goods sold

    5100

    3900

    4500

    Salaries

    2000

    2000

    2000

    Rent

    1800

    1800

    1800

    Other costs

    380

    300

    400

    Cash outflow

    9,280

    8,000

    8,700

    Net cash flow

    -780

    2,500

    -1,200

    Opening balance

    0

    -780

    1,720

    Closing balance

    -780

    1,720

    520

    Award 1 - 2 marks for an answer that shows some understanding of cash flow forecasting, although there 3 or more errors. Apply the own figure rule (error carried forward), as appropriate.

    Award 3 - 4 marks for an answer that shows good understanding of cash flow forecasting. For 3 marks, allow up to 1 error. Apply the own figure rule as appropriate.

    Return to 3.7 Cash flow homepage

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