Written by Nehal Desai - Associate Consultant with EDSI
Cash availability is critical for any business. Whether to pay vendors, creditors, or staff, having cash on hand is essential. Why then, is a good cash forecast so often overlooked and underutilized? Does your business maintain an accurate cash forecast? Are you using your forecast correctly to make the most effective and profitable business decisions? Having an accurate cash forecast can help identify potential future shortcomings and allow a business to take corrective actions to ensure their operations run smoothly! Read on to understand the basics of a cash forecast and how it can aid your decision-making process in times of low or high growth.
We often see businesses show increased sales and positive profits, yet, they still run out of cash. Simply stated, cash flow is the lifeblood of a business.
A cash forecast can accurately express a firm’s cash position in future periods. Commonly, a 13-Week Cash Forecast and an Annual Operating Plan (AOP) are preferred forecasting methods. The 13-Week Cash Forecast outlines the cash position for the upcoming 13 weeks, while the Annual Operating Plan (AOP) shows the monthly cash needs and surpluses for each month in a fiscal year. Most firms create an AOP at the start of the year and update on a regular basis. The 13-Week Cash Forecast is often used when cash is becoming (or has already become) a concern. It is a great way to manage cash in the short-term and make strategic changes to manage the cash position.
So how can cash forecasts be utilized in business decisions? Cash forecasts help companies manage their growth, working capital and lines of credit with lenders.
Imagine business is booming. Customer orders are rolling in faster than you can handle. You are ecstatic as profits are going through the roof. Soon, you realize that although profits are soaring, more cash is leaving your bank account than coming in. Now cash is not available to pay key vendors, and orders need to be put on hold. Sadly, despite the increased sales orders, the company is stuck without inventory and unable to fulfill demand. A 13-Week Cash Forecast, coupled with the right strategies, could have prevented this. Cash needs would have been estimated and preventive measures to avoid cash shortages executed.
Now imagine an opposite scenario. The sales forecast is down. There is hope on the horizon, but you are unsure of what your cash needs are for the next month. The cash forecast can help determine when collections and payments occur using the predictive nature of both sides of the transactions. Utilizing the forecast, firms can be aggressive in their collections when they foresee an upcoming cash shortage, or use the forecast to negotiate an increased line of credit with creditors. A cash forecast helps your company get ahead of the situation and take appropriate action to lessen or eliminate negative impacts associated with cash constraints.
A lack of positive cash flow and insufficient credit to finance the business is a common issue for underperforming businesses. A well-formulated cash forecast is the perfect solution to help manage a company’s cash and credit, and equip it with the right tools for long-term success
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