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Financial forecasting
cash flow forecasts
Starting point
We have seen in Chapter 12 that cash is the
lifeblood of any business. If the supply of cash dries
up, suppliers cannot be paid and employees do not
get their wages the business may become insolvent.
Cash is part of the working capital the liquidity of
a business, which is its cushion of short-term
resources, available to pay off debts such as
suppliers invoices and employee wages.
Another short-term resource is money borrowed from
the bank by means of an overdraft. A business will
clearly need to work out how much it is likely to have
to borrow. The bank will undoubtedly ask the business
to produce a cash budget a cash flow forecast
which is a projection showing how much money flows in and out of the
business bank account each month and highlights the months in which the
business may need to borrow from the bank.

What you will learn from this chapter

a cash flow forecast is a budget which estimates the need for bank
overdraft finance over a period of time, normally six or twelve months
a cash flow forecast is set out in the form of table with monthly columns
of figures showing (from the top) receipts into the bank account,
payments out of the bank account and the projected month-end bank
balance
a computer spreadsheet is a useful method of setting out the figures of
a cash flow forecast and can be manipulated to show the effects of
changes in receipts and payments on the month-end bank balance
a cash flow forecast is an invaluable financial management tool as it
indicates any shortage of liquidity and the need for a bank overdraft

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 Financial Forecasting Cash Flow Forecasts

the Importance of the Cash Budget

We have seen in the last chapter that the budgeting process in a business
involves:
estimating future income and costs
monitoring the figures over time to see if any variances occur (variances
are differences between budgeted and actual figures)
taking action if the variance is a significant
Income and costs all pass through the bank account which forms the basis of
the cash budget. This in turn provides data for the master budget of the
business the forecast profit and loss account and balance sheet. These two
budgets are particularly important when a business draws up a business plan
to present to a potential lender or investor. They provide information about
the profitability of the business and its liquidity its ability to repay debts.
As you can see from the diagram below, the cash budget is central to the
whole budgeting process. Study the diagram and then read on.

THE PLACE OF THE CASH BUDGET IN THE BUDGETING PROCESS

income costs
SALES BUDGET BUDGETED COSTS
what can we sell and what will it cost to run the
what sales revenue business?
will we receive?
production budget

marketing budget

finance budget

human resources budget

administration budget

capital budget

MASTER BUDGET
CASH BUDGET
forecast profit and loss
estimating receipts and payments and the
account and
amount of money in the bank account
balance sheet

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Format of a Cash Flow Forecast

A cash budget also known as a cash flow forecast is a table which

estimates the amounts of money coming into and going out of the bank
account each month. Study the example on the opposite page.
A typical cash flow forecast which normally estimates figures for six or
twelve months sets out in a column for each month three distinct sets of
figures:
receipts a totalled list of items paid into the bank account; these
commonly include sales, capital paid in, grants and loans from the bank
payments a totalled list of payments made out of the bank account;
these include items such as purchases of materials and stock, wages,
marketing and other expenses
the cash flow for the month and the bank balance at the beginning and
the end of the month

working out the monthly bank balances

The bank account balances are worked out in the bottom section of the
cash flow forecast and are related to the cash flow for the month.
cash flow = total monthly receipts total monthly payments
If the cash flow figure is positive it means that more money has come into
the bank account than has gone out; if the cash flow figure is negative it
indicates that payments out are greater than payments in. A negative cash
flow is normally shown in brackets or with a minus sign.
The cash flow is added to the opening bank balance (the amount in the
account at the beginning of the month) to produce the closing bank balance
(the amount in the account at the end of the month). If the cash flow figure
is negative it will be deducted from the opening bank balance. The
calculation using a positive cash is:
cash flow for month + opening bank balance = closing bank balance
The closing bank balance is then entered in the next months column as the
the next months opening bank balance it will obviously be the same figure
because it represents the bank balance on the very last day of the month.
Note that if a bank balance is negative it is shown in brackets, or with a
minus sign. This means that the business is borrowing from the bank by
means of an overdraft.
Now study the example on the opposite page. To keep things simple, all
balances shown here are positive.

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FORMAT OF A CASH FLOW FORECAST

the heading includes the name of the business individual columns

and the period of the cash flow forecast for each month

ARCHERS ENTERPRISES LIMITED

CASH-FLOW FORECAST

for 12 months ending 31 December

January February

Receipts
the total of the Sales 80,000 80,000
amounts paid
Capital introduced
into the bank
account during Loan 25,000
the month (A) Grant
Other income
TOTAL RECEIPTS FOR MONTH (A) 105,000 80,000

Payments
the total of the Purchases of stock 40,000 40,000
amounts paid
Equipment 30,000
out of the bank
account during Wages 10,000 10,000
the month (B) Marketing 2,000 2,000
Other running costs 5,000 5,000
TOTAL PAYMENTS FOR MONTH (B) 87,000 57,000
cash flow for
the month (A-B) CASH FLOW FOR MONTH (A B) 18,000 23,000

bank account at Opening Bank Balance 2,500 20,500

the beginning of
the month Closing Bank Balance 20,500 43,500

bank account at
the closing balance at the end of January is the same as
the end of the
the opening balance at the beginning of February
month

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Activity 16.1 cash flow forecast structure

You have been given figures for the estimated bank receipts and bank payments for three
businesses for the months of January and February.
You have also been given the opening bank balances for January for each of the three
businesses. Note that a bank balance in brackets is a minus figure; it shows that the
business will be borrowing from the bank on an overdraft.

JANUARY FIGURES
Apple Ltd Bruin Ltd Elstree Ltd

Total Receipts 20,000 40,000 64,000
Total Payments 10,000 24,000 62,000
Opening Bank Balance zero 6,000 (7,000)

FEBRUARY FIGURES
Apple Ltd Bruin Ltd Elstree Ltd

Total Receipts 20,000 40,000 70,000
Total Payments 16,000 25,000 80,000

1 Use the format shown below to calculate the bank balances at the end of January and
February for all three businesses. Use brackets to indicate any negative figures.

January February

Total Receipts for Month

Total Payments for Month

Cash Flow for Month
Opening Bank Balance
Closing Bank Balance

2 Explain what has happened to the bank balance of Elstree Ltd during January and
February. What does this say about the liquidity of Elstree Ltd and what implications
does it have for the future of the company?

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Using the Cash Flow Forecast

A cash flow forecast is a very useful tool for the financial manager:
it helps to estimate how much a business may need to borrow by way of
bank overdraft
it highlights any future liquidity problems a business may have in other
words it shows if a business may run into trouble in paying its debts
it is an important document in a business plan which will have to be
prepared if a business wishes to borrow from the bank
A cash flow forecast is also a very flexible tool. If it is set up on a computer
spreadsheet it can be used to calculate liquidity situations in a variety of
what if? situations. For example:
What will happen to the bank balance if monthly sales revenue
falls by 10%?
What will happen to the bank balance if the monthly wages bill
rises by 10%?
The Case Study that follows illustrates these points by looking at a mail
order business that sells cut-price DVDs.

Case Study using the cash flow forecast

a new business
Jo Dandini set up a mail order company in January
selling cut-price DVDs. She called her enterprise DVD
XPress.
She works from part of a warehouse which she rents
from a friend at a low rate.
She sells through her website which has an online
shop; she also accepts telephoned orders. Her sales
are mostly credit and debit card sales and she obtains
her supplies from trade wholesalers.
Jo employees part-time telephone operators and
packers; she also puts in a lot of time himself, adopting
a very hands-on approach to the business which
enables her to assess the market and manage the
business efficiently.

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financing the business

Jo has invested 12,000 of her own money as capital in the business and has
negotiated a bank loan of 8,000 to help her with her start-up requirements; these
include computers and mailing equipment.

revenue and costs

Jo has budgeted for monthly sales of 10,000 and 5,000 for monthly purchases of
DVDs. She has to pay for the DVDs in the month of purchase. She also has to pay various
monthly overheads, the largest of which is the wages bill.

preparing the cash flow forecast

Jo has been asked by her accountant to draw up projected figures for the first six months
of trading. From these figures the accountant can prepare a cash flow forecast which
can be presented to the bank in case an overdraft is needed.
The accountant stresses that these figures, particularly the sales and running expenses
will only be estimates.
Jo has opened up a business bank account but has not yet paid anything in. Her
estimated figures are shown below.

ESTIMATED FIGURES FOR THE CASH FLOW FORECAST

Receipts date amount ()

Capital provided by Jo January 12,000
Bank loan January 8,000
Sales of DVDs Monthly 10,000

Payments date amount ()

Purchases of DVDs Monthly 5,000
Purchase of equipment January 14,500
Purchase of equipment February 15,250
Rent of warehouse Monthly 575
Insurance Monthly 50
Electricity March, June 100
Telephone Monthly 100
Wages Monthly 1,000
Postage Monthly 450
Marketing Monthly 200

preparing the cash flow forecast

Jos accountant discusses these figures with her and then prepares a cash flow forecast,
using a computer spreadsheet. This cash flow forecast is shown on the next page.

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 Financial Forecasting Cash Flow Forecasts

cash flow forecast 1

The accountant explains the cash flow forecast as follows:

sales revenue is assumed to be 10,000 per month this is only an estimate, the figure
could be higher or lower
the purchases figure in the Payments section is the cost of buying in the stock the
business has a mark-up of 100% (ie Jo doubles the cost price to get her selling price)
the cash flow for January is 8,125 and as there is no money in the bank at the
beginning of the month, this cash flow is also the balance at the end of the month (and
the beginning of February)
the cash flow for February is a negative figure (12,625) because of the purchase of
the equipment and there is not enough money in the bank to cover this as a result the
business ends the month of February with an overdraft of 4,500
the cash flow for March is an improvement at 2,525, but the business still has an
overdraft at the end of the month of 1,975
from April the end-of-month balance is positive and the month-end balances continue
to increase in May and June
The accountant explains that the bank should be happy to grant the overdraft shown on
the cash flow forecast because the projection shows that it will be repaid. But Jo is worried
about the accuracy of her projections and asks what would happen if sales were only
7,500 a month, or looking on the brighter side, 15,000 a month.
Jos accountant promises to draw up two more cash flow forecasts incorporating these
figures (and adjusted purchases figures too) see the next page.

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cash flow forecast assuming sales rise from 10,00 to 15,000 a month

cash flow forecast 2

cash flow forecast assuming sales fall from 10,000 to 7,500 a month

cash flow forecast 3

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 Financial Forecasting Cash Flow Forecasts

Activity 16.2 cash flow forecast analysis

Study the three cash flow forecasts for DVD Express on the previous two pages and
answer the questions below.
Bear in mind that a cash flow forecast relates to other financial calculations and
statements that you have studied. A cash flow forecast, like a break-even calculation, is a
forward-looking financial projection which deals with income from sales and various
types of cost. Note also that many of the figures on a cash flow forecast are to be found
in a profit and loss statement; they contribute to the projected profit and loss account
which forms part of the master budget.

questions

1 Refer to cash flow forecast 1 on page xx.

(a) What is the balance of the bank account at the end of June?
(b) In what month will the overdraft be repaid?
(c) What is the main reason for the month-end bank balance for January being
positive and the month-end balance for February being an overdraft (negative)?
(d) What are the total sales and purchases of DVD Express for the first six months?
(e) What is the percentage mark-up of the business?

2 Refer to cash flow forecast 2 on page xx.

(a) Why is no overdraft needed by Jos business for the first six months of trading?
(b) What is Jos gross profit for the first six months of trading?
(c) What is the percentage mark-up of the business?

3 Refer to cash flow forecast 3 on page xx.

(a) What is the main effect on cash flow of sales revenue falling to 7,500 per
month? What effect might this have on Jos plans?
(b) Jo reckons that she should cut some of her costs if sales fall to this level. But why
should the monthly cost of purchases fall to 3,750 and other costs such as
rent and wages remain the same. What type of costs are these?
(c) Is there any other way in which Jo could cut her costs in her first six months of
trading?
(d) If Jo approached the bank with a request for an overdraft with this cash flow
forecast, what is the likely reaction of the bank?

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Cash Flow Statements on a Computer Spreadsheet

This chapter has already illustrated how a computer spreadsheet can be used
to set out a cash flow forecast. There are a number of advantages of using a
computer spreadsheet:
complex calculations can be performed automatically
the effect of what if scenarios can easily be set up and illustrated (as in
the Case Study)
The illustration below shows the structure and formulas that are needed to
set up a suitable spreadsheet.

CASH FLOW FORECAST SPREADSHEET WITH FORMULAS

Cash Flow Statements Alternative Format

The format of cash flow statement shown in this chapter is widely used in
business. Some spreadsheets adopt a slightly different approach to the way
in which they deal with the bottom section. Instead of starting the section
with cash flow for the month and then adding it to the bank balance at the
beginning of the month, the alternative formula takes up four lines (rows of
cells on a spreadsheet) and is set out as follows:

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 Financial Forecasting Cash Flow Forecasts

Opening bank balance

+ Total Receipts
Total Payments
= Closing Bank Balance
The end result of the calculation is exactly the same, the bottom line showing
the bank balance at the end of each month.

Activity 16.3 constructing cash flow forecasts

You have been asked to draw up the cash flow forecasts for two businesses for a six
month period. The figures are shown below.
You are to:

1 Construct both cash flow forecasts, using a computer spreadsheet if you wish (see
opposite page for the formulas).
2 Comment on the cash flow of both businesses and explain the trends in the month-end
bank balances.

ARBOR DESIGNS
Jan Feb March April May June

Receipts
Capital 20,000
Loan 15,000
Receipts from clients 12,000 12,000 12,000 12,000 12,000 12,000
Payments
Equipment 25,000
Materials 5,000 5,000 5,000 5,000 5,000 5,000
Other expenses 2,000 2,000 2,000 2,000 2,000 2,000
Opening bank balance zero

GIGA CATERING
Jan Feb March April May June

Receipts
Sales 30,000 30,000 30,000 30,000 30,000 30,000
Payments
Stock and catering materials 15,000 15,000 15,000 15,000 15,000 15,000
Other expenses 5,000 5000 5,000 5,000 5,000 5,000
Purchase of of cooking equipment 15,000 30,000
Opening bank balance 1,000

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CHAPTER SUMMARY

The cash budget also known as the cash flow forecast projects all income
and payments which pass through the bank account, and so is central to the
budgeting process in a business.
The cash flow forecast provides data for the master budget, which sets out a
projected profit and loss statement and balance sheet for the business.
The cash flow forecast is set out in three sections: receipts, payments and cash
flow for the month.
The cash flow for the month is calculated as follows:
CASH FLOW = TOTAL MONTHLY RECEIPTS TOTAL MONTHLY PAYMENTS

If the total of payments is higher than the total of receipts, the cash flow becomes
negative and is shown with a minus sign or in brackets. This means that the
liquidity of the business is under pressure and the business may not have the
resources with which to repay its debts.If the total of receipts is higher than the
total of payments, the cash flow is positive, which is good for liquidity.
The cash flow section adds the monthly cash flow to the bank account balance
at the beginning of the month to calculate the bank account balance at the end
of the month, which is shown on the bottom line of the cash flow forecast. If the
cash flow is negative, it will be deducted from the opening bank balance. The
formula is:
CASH FLOW FOR MONTH + OPENING BANK BALANCE = CLOSING BANK BALANCE

If the figure for the closing bank balance is positive it indicates that the business
has money in the bank; if the figure is negative it means that the business will be
borrowing from the bank by means of an overdraft. An overdraft (negative
balance) is shown either with a minus sign or in brackets.
The closing bank balance for the month is entered on the cash flow forecast as
the opening balance for the next month, as it will always be the same figure.
The cash flow forecast is useful for a business because it shows how much the
business will need to borrow and also if the business will have liquidity
problems.
The cash flow forecast is an important part of a business plan which is presented
to the bank when a business needs to request any form of borrowing.
A computer spreadsheet is a useful way of setting up a cash flow forecast and
will allow the business to see the effect of changing income and costs using
what if scenarios.

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KEY TERMS

cash flow forecast a budget (also known as the cash budget) which
presents the projected monthly flows of money in and
out of the bank account and forecasts the month-end
bank balance

master budget projected profit and loss account and balance sheet
which use data from the cash flow forecast normally
included in the business plan to support an application
for financing

cash flow the difference between receipts into the bank account
and payments out of the bank balance shown on the
cash flow forecast either as a positive or a negative
figure

opening bank balance the bank balance at the beginning of the month
added to the cash flow for the month on the cash flow
forecast

closing bank balance the bank balance at the end of the month, shown on the
bottom line of the cash flow forecast

overdraft short-term borrowing from the bank on the business

bank account, shown on the bottom line of the cash
flow forecast as a negative figure

liquidity the ability of a business to pay off its debts as they

become due

what if scenario suggesting different situations when setting up budgets

and other financial projections, eg increased sales
figures or increased costs, a process which is made
much simpler by the use of computer spreadsheets

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