Can you Really Forecast your Cash Flow?

Why not having the right budgeting tools can mislead you in forecasting your cash flow

By Alan Hart, MBA

Are you comfortable with your accuracy in the forecasting of your cash flow?  Does your organization forecast its cash flow (and its cash needs) at all?

It is not surprising to learn that many organizations do not, or are unable to, reliably and accurately forecast their cash flow as part of their annual budget preparation process.  When I say “reliably and accurately”, I simply mean, accurately distributing (i.e., logically derived from) your assumptions and data entry, into your revenue and expense budget items and letting your budgeting software calculate the forecasted financial statements and all other reports.

No one can accurately predict the future; including what your cash balances are going to be during your budget planning process.  But, if you can ensure that your assumptions get properly applied, you can, however, arrive at a surprisingly accurate forecast of cash flow, based upon the accuracy of your forecasted revenues, expenses and other transactions (e.g., purchase and disposals of fixed assets, investments and borrowings) that affect cash flow.

In my experience I have seen two distinct groups of organizations.  The first group consists of those who do not forecast their cash flow, or do not do it in a manner consistent with all forecasted budget items (e.g., revenues, expenses).  This group represents the majority of budget preparers.

The other group consists of organizations that have acquired the right tools to enable them to truly forecast their periodic cash balances throughout their budget plan, gaining insight into much valuable information.

What separates the first group from the second is the willingness to make the effort  and having the right forecasting tools.  If you are in the first group, you may wish you could forecast your cash flow (or preferably your entire Balance Sheet) but simply cannot do that at present time.

You may be using a spreadsheet method, or perhaps your organization has licensed a budgeting software application, which unfortunately requires significant programing, but only approximates your forecasted Balance Sheet and Statement of Cash Flows.

If you use a spreadsheet or a specific budget and forecasting software application that requires you to enter formulas and link worksheets, you are limited in your ability to truly, confidently, forecast your cash flow.  These tools are simply not designed to do that, as a detailed balance sheet cannot realistically be programmed to provide accurate future account balances.  There are far too many types of transactions that affect cash, and within certain transactions (e.g., A/R and A/P) there are additional variables (e.g., several types of payment terms).

At best, these software applications approximate the cash balances and perhaps other balance sheet items.  Most organizations do not have much confidence in these forecasts, or perhaps ignore them altogether, while only focusing on the forecasted revenue and expenses.

To really be able to forecast your cash flow you need to be using a purpose built application that seamlessly generates a balance sheet, entirely derived from your budget plan components (forecasted revenues, expenses, fixed assets, lines of credit and loans, etc.), and all additional (and often subtle) assumptions, assigned to individual budget lines (e.g., receivables and payables payment terms, individually selected for each revenue and expense item).  Spreadsheets and many existing budgeting applications simply cannot accomplish that.

Experience and research shows that the vast majority of budgeting and planning software was not designed to seamlessly produce any meaningful financial statements beyond the Income Statement and thus the Balance Sheet will not be accurately derived from your detailed forecast, and the Statement of Cash Flows will not be automatically generated from the forecasted Income Statement and the approximated Balance Sheet.

The reason for that is that unless the software treats each budget item individually in terms of their unique payment terms (e.g., 30 days AR, 60 days AR, 30 Days AP, etc.) and other attributes (e.g., individual revenue recognition schedules, unique expense spread patterns, etc.) the software cannot possibly know when to expect customer payments or when you need to make payments to vendors.

To make this work, you need a system that is a true extension of your actual accounting system where all transactions are represented by journal entries (think automatic credits and debits to your budget GL accounts in the right budget periods, in the correct amounts and, of course, to the right GL accounts.  When you have such a system, all budget pieces seamlessly fall into place and form your expected forecasted financial statements, including a Balance Sheet and a Statement of Cash Flows.

Think of all the hard and tedious work that goes into programming a budget, that doesn’t begin to deliver what it is supposed to, not to mention programming errors and various omissions (usually undetected) that often result.  It is much better to find a software tool that acts as a future representation of the general ledger, giving you the familiar financial statements, completely accurate, and directly affected by your budget assumptions.  More on such a system in a future post.

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