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Cash Flow Learning Trail
Forecast and actual cash flow - why do they differ?
Before we examine methods of funding Cash Flow shortages or deficits it is worth examining why Forecast and Actual (Historic) Cash Flows can differ.
Cash Flow Forecasts are a prediction of the likely flows of cash into and out of a business. They will be based on:
- Past experience, ( when the business has a previous trading history )
- Current and likely future economic and financial trends.
- The knowledge and understanding of the managers/owners.
- And, the future plans of the business.
As with all forecasts, the further we look into the future, the less certainty we have. Because of this, and because businesses operate in a world with changing fashions, changing economic climate, and changing competition, a businesses' Actual Cash Flow Statement can in some cases be very different from its Cash Flow Forecast.
Typical Reasons for Variations between Actual and Forecast.
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Sales are not at the expected level. This could be for several reasons;
- Increased /decreased competition.
- Economic growth /decline.
- Changing spending patterns of consumers /changing fashions
- Government influences, e.g. increased or decreased taxation.
- Raw materials costs increase or decrease.
- Interest rates change, affecting demand, and the costs of those businesses with loans.
- Debtors pay later than expected.
- Increased labour costs.
All businesses should monitor cash flow and examine any differences between actual and forecast figures. This will allow action to be taken before a real business crisis arises. As experience is gained of managing and monitoring cash flow business owners and managers will be able to improve the accuracy of their forecasts.
But what happens when a business needs cash, or liquidity? Up to now we have just referred to cash, but the fact is we are talking about the liquidity of business. Liquidity is a measure of the availability of Working Capital. If managers of a business say
they have a liquidity or working capital problem, this means that they will have a problem meeting all their immediate expenditure demands. i.e. they do not have enough cash in hand, do not expect enough cash to be flowing into the business and cannot convert
enough assets into cash in the short term to be able to pay all their bills, wages, debts etc. That 'and' is important, firms do not always (in fact rarely) need to keep enough immediate cash on hand to meet likely future expenditure, what they must do though is keep enough 'liquid assets' available, so that cash flow can be effectively managed.
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