Skip to main content

Cash flow forecasts A2, AO4

AO2 You need to be able to: Demonstrate application and analysis of knowledge and understanding Command Terms: These terms require students to use their knowledge and skills to break down ideas into simpler parts and to see how the parts relate: Analyse, Apply, Comment, Demonstrate, Distinguish, Explain, Interpret, Suggest

AO4 You need to be able to Demonstrate a variety of appropriate skills. Command Terms These terms require you to demonstrate the selection and use of subject-specific skills and techniques: Annotate, Calculate, Complete, Construct, Determine, Draw, Identify, Label, Plot, Prepare

Firms usually exist to make a profit. However, it is also important for firms to monitor their cash flow position, otherwise they may not be able to pay their bills, supplier costs or wages. If they do not pay these they may be faced with closure.

It is vital, therefore for managers to track their cash flow position.

A cash flow forecast

A cash flow forecast is an estimate of when and by how much cash flows into and out of an organisation over a specific time period, usually one year.

A cashflow forecast contains three main elements:

  1. Cash inflows may arise from cash sales, debtors paying what they owe, interest received, bank loans, rent payments and disposal of assets.
  2. Cash outflows occur when the organisation pays its creditors, makes cash purchases, buys assets, pays taxes, wages and rent and any other cash outgoing for business expenses. Not all of these pass through the profit and loss account.
  3. Net cash flow is the difference between cash inflows and cash outflows. Ideally this should be positive, although organisations can survive negative cash flows if it can find cash from other sources, such as an additional bank overdraft.


A positive cash flow is not profit and a negative cash flow is not a loss. Do not use these terms interchangeably.

A profitable business may run out of cash - this is called insolvency. This could be the result of selling output with too long a credit period or tying up funds in new assets. According to the UK Department of Trade and Industry more business failures result from lack of cash than any other reason. This is particularly true for new businesses. Too little cash can result in the following problems:

  • Non payment of suppliers
  • Discounts lost for late payment of bills
  • Wages and salaries may not be paid on time, causing poor motivation, high labour turnover, absenteeism and industrial unrest
  • New capital assets cannot be afforded
  • Tax cannot be paid.

Managing cash flow.

To manage cash, a firm will need to assess:

  • The size and timing of cash flows into the business
  • The size and timings of cash flows out of the business
  • Whether there are other sources of finance to cover short term need for cash

Cash-flow forecast.

flow_tap.pngA cash-flow forecast is an attempt by management to plan ahead and prevent future liquidity problems. Each month a firm estimates the amount of cash entering and leaving the business and whether this will result in a cash deficit (overdraft) or surplus. If an overdraft is predicted, the managers will have to consider potential solutions. These could include:

  • Arranging an overdraft with a bank
  • Arranging a longer term loan
  • Rescheduling payments or considering alternative purchase solutions, e.g. hire purchase, or possible leasing arrangements
  • Selling assets or postponing purchases
  • Finding cheaper suppliers
  • Reducing credit terms for customers or lengthening credit terms with suppliers

Some businesses are highly seasonal, e.g. farming, tourism. It is likely that firms in these industries will experience some cash-flow problems. If they make arrangements with banks to cover these periods then problems of insolvency may not arise

Alternatively, a firm may have too much cash during the year. This may result in the loss of interest as longer-term investments carry higher interest rates. Firms could also purchase more productive assets.

Cashflow Forecast

Example 1 - cash-flow forecast

A typical cash-flow is shown below:

New Horizon Holidays

Cash flow forecast year ($000s)

Month Jan. Feb. Mar. Apr. May June July

Cash sales 100 120 240 280 430 500 540
Payments from debtors 50 100 100 140 200 340 450
Other (loan received)


Total cash inflows 150 220 340 420 710 840 990


Labour 20 40 50 60 100 180 200
Flights 40 75 90 100 180 190 210
Hotel bookings 30 80 120 140 250 260 300


Advertising 5 30 30

Electricity 15


Rent 50


Salaries 50 50 50 50 50 50 50
Purchase of fixed assets


Total cash payments 210 295 340 475 600 680 825

Net cash flow (60) (75) (0) (55) 110 160 165
Opening cash balance 70* 10 (65) (65) (120) (10) 150
Closing cash balance 10 (65) (65) (120) (10) 150 315

* January's opening balance of $70,000 is the closing cash balance from December

Similarly, January's closing balance of $10,000 becomes the opening balance of February.

Figures in brackets are negative, i.e. negative cash flow - an overdraft.

\\\file server\TripleA\Design\icons\small\tip.gif

Examiners like to add complications to cash flows. The most common are:

  • Delayed payments or receipts. It is common practice for firms to buy and sell products on credit. The examination question may give a table of sales or purchases but then say that the credit term is one month. It is important that you make the cash flow or inflow one month later. Remember this is cash forecast, not a record of other assets. In the following example the goods received in January are not paid for until February:

Jan Feb March April May June July
Good received ($000) 20 30 30 25 40 50
Payment - cash outflow
20 30 30 25 40 50

  • Asset purchases made in instalments
  • Payment such as electricity may be payable every quarter

The important thing is to make sure that the timings of the cash inflows and outflows are accurate.


Example 2 - Interactive cash flow forecast

Follow the link below to open up an interactive spreadsheet of a cash flow forecast. In this spreadsheet, you can change the values of the various receipts and payments and see the impact on the firms cash balance. Once you have experimented a bit with changing values, reset the spreadsheet (using the 'reset' button) and try the following questions.

Interactive cash flow forecast



Cash flow forecast

What will be the final cash balance if the firm's rent increases to $300?

If the rent increases to $300, the final closing cash balance will be reduced to $188.Check your answer


Cash flow forecast

How much can general office expenses increase by before the firm starts to suffer from a negative closing cash balance?

If general office expenses increase by $64 to $139, the firm will end up with a final closing cash balance of $4. If the office expenses go up by $65, then they will end up with a final closing balance of -$2.Check your answer

Perils of cash flow forecasting

A firm prepares a forecast, no more. It makes assumptions when preparing the forecast and there is no guarantee that all expectations or assumptions will be met. This means that cash flow forecasting has to be a continuous or ongoing process. The firm needs constantly to check on the cash position and identify problems before they happen, otherwise the firm may find itself in a liquidity crisis.

A liquidity crisis may be caused by a number of factors including:

  • Overstocking happens if the firm does not match its production or purchasing with final demand patterns and holds too much stock, which ties up liquid funds.
  • Overborrowing creates significant interest payments. If interest rates rise, these payments may be unsustainable.
  • Unexpected changes in the external environment may occur, such as seasonal variations and sudden changes in demand patterns.
  • Poor credit control can cause liquidity issues if the firm allows too much credit some of which may go 'bad' in recessionary times.
  • Overtrading occurs when a firm expands without securing the necessary long-term finance, which results in the reduction of working capital. If a firm accepts new orders, these may be profitable when sold. However, production ties up liquid funds in assets such as work-in-progress and the storage of stock as well as paying production expenses. The firm will not recover its liquidity until payment is made for the goods, which may not be for a long period, especially if the purchaser takes advantage of a credit period.