…and why spend time and money forecasting cash flows? Cash flow, or more specifically, operating cash flow is simply the net cash position — cash in less cash out — in a given period of time: a year, a quarter, a week or even a daily cash flow. The utility – why do it – is simply to have a better understanding of the firm’s liquidity as it moves from the present into the future. Rather, to understand whether the company will be able to pay its bills or not, with or without outside financing – debt or equity infusion – of some sort.
There are difficulties, problems, challenges in developing a useful cash flow forecasting model. A couple of points to keep in mind:
- A cash flow forecast isn’t simply a report of actual results and ratios thereof at some point in time.
- A cash flow forecast isn’t a prospective pro forma with periodic revisions.
- A cash flow forecast, rather, begins with actual account balances at present and forecasted changes to these balances based on expected transactions into the future. (It may or may not include historical “actual versus forecasted” results for previous periods.)
- The cash flow forecasting accuracy is impacted by a number of analytical preferences of the forecasting / management team as data issues, including:
- Forecasting time period(s): annually, quarterly, monthly, weekly or daily.
- Whether multiple time forecast periods are required.
- How often the cash flow forecast is used.
- How often and when the data can be refreshed.
- Lags between when a transaction will occur and when data referencing the transaction will be available for analysis purposes.
A discussion of each of these issues will be expanded upon as time allows.
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