Cash flow is vital to the financial stability of every business – from the smallest to the largest. Therefore, every entrepreneur should become familiar with the cash flow statement.
Forecasting cash flow is a necessary foundation for future planning, enabling you to measure actual results against goals: meeting specified targets validates your initiatives, while missing targets identifies where improvement is needed.
However, a number of common errors with cash flow projections will result in poor strategic decisions. For example, projecting operating income is often the cause of cash flow blunders. This top line of the projected cash flow statement should represent a realistic profit forecast based on available resources.
The best starting point is a separate projection of revenue and expenses, and subsequently, an examination of changes in receivables and payables. This is accomplished by using figures for the average number of days that receivables and payables are outstanding. Cash flow is different from income because of the lag between sales and collection, as well as the lag between receiving a bill and paying it.
Other cash flow variables are investments and financing. These do not appear on the income projection, so they appear on a cash flow forecast. Investment in a new asset – such as machinery or equipment – subtracts cash. Financing these purchases by borrowing adds to cash.
Those entrepreneurs familiar with the components of cash flow statements can recognize the forecasting limitations, and they will seek professional accounting assistance to overcome these limitations.