Cash flow refers to the total amount of cash you have coming in to your business, less the amount of cash you are going to need to cover your expenses and debt service. In other words, your cash flow equals your net profit + depreciation + PP&E amortization – capital expenditures. Cash flow forecasting specialists often think of this definition as a “running balance”. Cash flow is the lifeblood of a business and it carries the whole company through its growth or decline. During healthy periods of growth, cash flow will be flush; during downturns, cash flow will be scarce. You need to pay attention to how your cash flows in and out of your business because it can tell you when you are on the right track or headed for trouble down the road.
Fintalent’s cash flow forecasting specialists in the finance industry use cash flow forecasting to predict the future state of a company. There is no point in making a purchase if you cannot make projections on its success or lack thereof because the forecast will determine if you have enough capital to continue operations. Cash flow forecasting is one of many excellent tools that can be used to make informed decisions about a possible business transaction. This article will focus on cash flow forecasting and what it entails as it relates to mergers and acquisitions.
A cash flow forecast looks at an entire year, but can also look further into the future if necessary, and outlines which operating cycles will be used (such as day-to-day, monthly, quarterly). The most important aspect of a cash flow forecast is to determine the cash required in the operation. To be successful, one must be able to predict how much will be generated by each cycle and the effect that each cycle will have on its success.
A cash flow forecast should include roughly ten different cycles which outline how many dollars a company can generate through each cycle. The expected gross margin (the amount of money earned after all expenses are paid) is also listed, because this is one of the most important aspects of a business. The more you can get out of your gross profit margin, the more cash you have to manage your costs and keep profit margins high over time.
With cash flow forecasting, one can also optimize an M&A strategy as well. By knowing how much money a company will produce in a certain time frame, one can determine how much money they need to go after. For example, if the forecast predicts $10 million in gross margin over 24 months, it means that the company is generating a gross margin of 10% per year (the number 12 times 30% equals the projected gross margin). If the investment amount is $3 million, then you know that cash flow will be $600K per month (the number 30 divided by 12 times 3). This is a good indication of how much money there is to be made, and whether the acquisition will be profitable.
Cash flow forecasting has changed in recent years, with the emergence of a new industry segment called “intelligent cash flow forecasting”, which can help make better investment decisions. One method is predictive modeling, which helps predict future outcomes based on previous trends, as well as external (e.g., macroeconomic) trends that can affect a corporation’s business model and performance.
Climatic change can affect cash flow forecasting with the change in average temperature and freeze/thaw cycles in Texas. A new industry has blossomed here since 2011, providing a business model where they will generate both cold and hot water. The company designs drinking water systems that allow our customer to use cold or hot water, bypassing the necessity of using multiple systems. They can now provide their customers with a single source of drinking water that meets our customers needs. Because there are multiple temperature cycles in Texas, companies such as this one need to be able to predict future business outcomes and make informed decisions on future capital investments.
When forecasting cash flow, it is important to be able to predict a company’s gross margin. Gross margin is the amount of money a company will make after all expenses and costs are paid. Gross margin will determine whether the company can remain sustainable in terms of cash flow.
Gross Margin = Revenue – Cost of Goods Sold
Gross Margin Example:
Cash Flow Forecasting differs from Cash Flow Management because forecasting is concerned with looking at historical performance as well as external factors that may affect a business. A more complex and detailed model is required for forecasting cash flow, which helps businesses determine their future state based on past performances, along with future trends in debt, equity and more complex financial instruments.
Cash Flow Management is more concerned with managing a business in the here and now. Cash flow management focuses on what can be done to improve performance and profitability. Cash is managed using a variety of techniques, such as cost reduction (purchasing/production cost reduction, selling/distribution cost reduction, marketing and advertising cost reduction, general administrative costs reduction) or revenue generation (product price increase, quantity increase).
There is little difference between cash flow forecasting and cash flow management. This type of analysis will help determine how much money an organisation has in its account at any given time. Cash flow management focuses on how to better the organisation’s performance and delivery of products, while the cash flow forecasting should focus on how to improve profitability.
Although there are no hard and fast rules, forecasting cash flow is most commonly used in a three-stage process. The first stage is done by examining past performance and examining sources of earnings. The second stage is predicting what could happen with the company’s business model during the next period of time. Finally, the third stage predicts what will happen during the next period of time based on knowledge such as market trends, cost structure and existing capacity constraints.