Finance & Capital mentor Stephen King responds:
Cash flow forecasting and the reporting of actual cash flow results are two critical activities that go hand in hand.

A good cash flow forecast, also called a cash flow budget, is at the core of the corporate financial process and is important for corporate survival. How can you get somewhere if you don't have a map to follow? How can you ensure that you will have the financial resources available to fund your company's growth or to just "make payroll" if you don't plan out the cash receipts and disbursements for the week, month, and year? You can't!

Your cash flow budget doesn't have to be intricate to be effective. You can use a spreadsheet, purchase a simple budgeting program, or even do a forecast by hand. The important thing is that you have one.

To create one, use your financial or income statement monthly forecast and a calendar year for financial reporting, and do the following:

  • Outline the expected collections from your budgeted monthly invoicing. If your terms are net 30 and your clients typically pay in 45 days, use this fact as your basis for forecasts. For example, under that scenario, March's invoices become May's collections.
  • For the first months of the year, add in when you expect to collect existing accounts receivable. If you have $20,000 in accounts receivable that were all invoiced in December of the prior year, then, based on the above assumption, the $20,000 should be added as projected cash inflow for the second month of your budget, which is February.
  • Identify any other expected cash receipts. In your cash receipts forecast, include proceeds from bank loans or equity transactions, refunds, and customer deposits.
  • Start looking at expenses and cash disbursements. Look at your expenses for the prior and current months and identify when they will be paid. Items such as payroll, rent, leases, travel, and entertainment are either recurring or paid out in the current budget month. Also, identify what fixed asset purchases and loan repayments you will make during the year.
  • Review your accounts payable balance at the end of December for the prior year, and identify when these items will be paid. Add the amounts to your cash disbursements forecast.
  • Do not include noncash expenses. Items such as monthly depreciation and amortization do not involve cash outlay but are included in your company's financial statements.

Once you have a cash flow forecast, share it with key staff members, who will help you achieve your monthly financial and cash goals --- or review it with your accounting adviser. He or she can provide valuable input because he or she already has a thorough understanding of your financial statements.

Don't expect to have a perfect cash flow budget the first few months. The best advice I can give you is to make sure that you review your actual results for the month against your forecast and review any significant variance. Update your budget forecast when significant new information is introduced, such as a new equity offering or a big sale not in your original forecast. You should also update your budget to reflect new activities that will reduce your expected cash flow.

To use the budget effectively, review it at the beginning of the month using a list showing outstanding accounts receivable and accounts payable. Identify those accounts receivable invoices that you expect to collect this month and those accounts payable invoices that you expect to pay. Add to those invoices estimates of collections and payments that you expect to have but are not yet on your list. Does the difference between your receipts and payments equal the amount you originally budgeted? Is it an amount that you can afford given your current and future cash position?

Once you answer these two questions, you should share your goals with those staff members who can help you reach them. Whoever is collecting invoices should be aware of those invoices that you need collected. Review the accounts receivable list weekly against your goal. Throughout the month, make payments within your budget so that you end up at your budgeted net cash flow.

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