The Nuts and Bolts: Preparing a Cash Flow Forecast

Nuts and Bolts

Introduction

Following on from our last article of 27 April 2020 on cash flow considerations, we now outline in this article the “must-have” information required to prepare a Cash flow Forecast, an item which is always asked for by potential lenders and which causes the most headaches for businesses to prepare.

The importance of a cash flow forecast cannot be overstated, as it indicates whether the business has seriously looked at its cash flow needs logically and systematically and has built in factors to take account of uncertainty, so crucial in the volatile climate that exists currently, where future demand is
so unpredictable.

In our experience the information listed below will enable a skilful preparer, either in-house or with the help of an external accountant, to put together a cash flow forecast that would satisfy a lender and its underwriters (it is assumed that it will form part of a properly put together pack that facilitates a lender to make a complete assessment without undue reference back to the company):

1. Monthly Management Accounts

As a minimum, you will need to prepare management accounts for the previous 12 months. Management accounts provide the starting blocks to preparing a cash flow forecast (“hindsight is the best predictor”). While we believe that it won’t be business as usual (as we discussed in detail in our article on the 27 April 2020 Embracing change in your cash flow forecast) we still feel that there are many factors included in your historical data will still be relevant into the future.

The importance of monthly management accounts is that they can be used as a tool to enable one to analyse different trends within a business. The analysis will, in turn, allow one to determine which factors (both internal and external) affect the profitability of a business. To ensure that this tool can be used effectively, thought should be given to the business’s chart of accounts.

Furthermore, one must ensure that all transactions are classified and posted to the correct account headings.

2. Costing Model

A costing model provides a detailed calculation of a business’s gross profit margin, the main driver to a successful and sustainable business, breaking it down over different products or services. It is a major component of preparing a cash flow forecast. Due to likely changed supply chains Post Covid-19 there may be some items where future margins on some items erode beyond commercially acceptable levels, and these need to be identified now.

For example, if your business imported goods you may face several challenges in securing your supply post-Covid-19. There is a strong possibility that the ports may experience congestion and you could face significant backlogs in production/supply of goods you require to import from various geographies. As a result, you could find yourself in a situation whereby you are unable to secure a constant supply of goods (raw material, consumables and finished goods). This could have a significant impact on your supply chain management and that may require significant changes such as sourcing the goods locally.

It is therefore important to take the time to ensure that the principles applied in preparing this model applies to a specific industry and to include all the factors that are relevant in determining your business’s gross profit margin.

3. Debtors and Creditors Ageing

It is important to ensure that your business’s trade debtors and trade creditors ageing reports are up to date as these provide the necessary detail to understanding the timing of your business’scash inflows and outflows.

Such exercise ensures that:

  • Customer receipts are allocated to the correct sales invoices and
  • Supplier payment is allocated to the correct supplier invoice

Other important controls include ensuring that supplier and bank reconciliations are prepared and reviewed monthly.

4. Management Discussions

To ensure the cash flow statement has integrity you must have discussions with all key management personnel within the business to discuss the likely adverse changes that Covid-19 will have on the business environment.

These discussions will ensure that key members of your business agree with the changes that potentially need to be implemented as a result of Covid-19 which in turn will ensure that a seamless approach is followed when implementing the action plan reflected in the cash flow forecast. (Details regarding these factors are discussed in our article on the 27 April 2020 Embracing change in your cash flow forecast)

The management discussions are a “planning phase” and provide a clear idea of what assumptions one will need to make and incorporate into the cash flow forecast.

Please note

The items discussed above are examples of information one will be required to prepare before being able to start a cash flow forecast.

By paying careful consideration and attention when preparing these items, one ensures that a logical and thoughtful cash flow forecast is prepared in a timely and cost-effective manner. We recommend that the requisite time and attention are expended to collate and prepare the above information to prepare a cash flow forecast based on accurate historical information.

From this, clear ideas will be derived that will, in turn, provide for a high degree of credibility to a reviewer.

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