When analysts provide forecasts of both earnings and operating cash flow, they also implicitly provide a forecast of total operating accruals. Thus, cash flow forecasts enable parties external to the firm to more readily decompose an earnings surprise into the portion attributable to unexpected cash flows and a portion attributable to abnormal accruals.
It can predict the impact of different decisions, like hiring a new employee or changing the business location, on the company’s financial cash health.
- Identify potential shortfalls in cash balances in advance—think of the cash flow forecast as an “early warning system.” This is, by far, the most important reason for a cash flow forecast.
- Make sure that the business can afford to pay suppliers and employees. Suppliers who don’t get paid will soon stop supplying the business; it is even worse if employees are not paid on time.
- Spot problems with customer payments—preparing the forecast encourages the business to look at how quickly customers are paying their debts. Note—this is not really a problem for businesses (like retailers) that take most of their sales in cash/credit cards at the point of sale.
- As an important financial planning discipline, the cash flow forecast is an important management process, similar to preparing business budgets.
- External stakeholders such as banks may require a regular forecast. Certainly, if the business has a bank loan, the bank will want to look at the cash flow forecast at regular intervals.
Accounting, bookkeeping, and tax tips to help you understand your small business finances.
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