In business, cash is king. Even the most profitable companies can have cash flow problems. Two accounting tools to help prevent cash flow problems are the cash budget and cash forecast. Each tool has a specific use. In most cases, they have a symbiotic relationship. Together they provide a thorough plan for a company’s future operations.
The cash budget requires three pieces of information: beginning cash balance, expected cash receipts and expected cash payments. The latter two items come from the cash forecast. Accountants will add together the beginning cash balance and the expected cash receipts, then subtract expected cash payments. A positive result indicates excess cash available for reinvestment into operations. A deficit indicates the company needs external financing to run operations for the upcoming period, typically 12 months.
Cash Receipt Forecasts
Companies estimate cash receipts and cash payments separately. Cash receipts represent all monies coming from customers who purchase the company’s goods and services. Estimating cash receipts comes from the sales forecasts accountants create based on the company historical trends. Accountants also include outstanding accounts receivable that will result in cash collected during the current period.
Cash Payment Forecasts
Cash payments represent all cash outflows for items needed to run the business. Accountants will review each department’s past spending trend and determine if expenditures are necessary. This information represents a basic expectation of future cash outflows. Previous years’ operating budgets provide good information for cash payment forecasts. This budget lists all expenditures for the business. Accountants can use the information to create cash payment forecasting and the cash budget.
Discounted Cash Flow
Discounted cash flow models are another type of cash forecasting method. This works by applying the time value of money principle to future cash flows. Accountants often use this method for individual projects or opportunities. Accountants estimate expected cash receipts and discount the cash flows for each year using the company’s cost of capital. The sum of these discount cash flows represents the value of a project or opportunity in today’s dollar value.