Business And Leadership, Ireland's Business News Service

In today’s world of financial stress and recession, good cash management is clearly of vital importance to all businesses. Cash-flow projection is one of the most powerful tools in managing money as it enables you to look at the cash flowing in and out of the business, assess future cash and funding requirements, and put appropriate facilities in place to meet requirements down the line.

Preparing cash-flow projections is similar to preparing budgets and should be part of the business budgetary process. Using the annual operating budget as a starting point, it involves predicting the timing of cash collection and payments for each of the items included in the budget. All non-cash items, such as depreciation and amortisation, should be excluded from these projections.

They should, however, include an estimate of the collection of receivables and payables from the end of the preceding period, as these will impact future cash flows. And it’s important to note that all amounts included in the projections should, where applicable, include value added tax (VAT) as this will also affect cash flow.

The projections should be prepared so that they analyse cash flows by week or by month and should be updated every week or month thereafter to reflect the actual situation. At a minimum, projections should be prepared for the next year and rolled forward every month so that you can look forward at least twelve months to assess when cash-flow difficulties may arise.

If you do not have an annual budget, preparing a cash-flow projection is likely to be more difficult and take longer. You should start by looking at your current position to gauge when current payables are due to be paid and when amounts owed to you are likely to be collected.

Regardless of whether or not you have prepared a budget, it is likely that most fixed costs such as payroll and rent will be consistent month on month. For variable costs, such as materials, light and heat, telephone and taxes, you should estimate the likely cost and timing of payment based on historical trends and any other relevant current information (eg predicted production cycles) that is available. Items of capital expenditure such as purchase of assets or payments related to acquisitions will also need to be included in cash-flow projections.

Be sure to document all assumptions as this information will be important to banks or other potential users of the forecast. You should also challenge your assumptions to ensure that they are reasonable (ie not overly optimistic) and stand up to scrutiny.

In these tougher times, businesses should also use this opportunity to look at what they are spending their money on to identify potential areas for cash savings, such as areas of discretionary spending like travel, subscriptions and optional benefits or bonuses.

Additional projections should also be prepared to reflect different scenarios so that you can see what the position might be if things don’t go as planned (eg loss of an important contract, increase in interest rates, unfavourable movement in foreign exchange rates, higher than expected bad debts, etc). This analysis may prompt you to examine your options even though you do not expect a problem based on current information.

It is also important that all current cash balances (including amounts in the business bank accounts) are included and that the projections include estimates of future cash balances, so that the business can anticipate its future cash and funding requirements based on the predicted levels of cash available. Future cash balances can be estimated by adding the projected monthly net flows from the cash-flow projection to the current cash balance. The model should be set up to calculate the projected cash balance at the end of each week or month, and identify peak cash requirements.

Spreadsheets are used by many businesses to prepare cash-flow projections, as they allow for quick and easy updating of figures to reflect actual numbers or changes in assumptions. The projections should be prepared in a format that is suitable for presentation to banks and other interested parties. This can be done by ensuring that all receipts and payments are analysed into appropriate headings based on the nature of the income or expense and that the report has appropriate totals and sub-totals, so it’s easy to see the opening cash balance, total inflow, total outflow, net flow and the closing cash balance for each period.

Spreadsheets can also be used to look at different scenarios. This can be done by preparing separate sheets to reflect various scenarios. It’s possible to link each of the scenarios to the original projection so that they can be automatically updated to take account of changes to the projection.

Furthermore, assumptions can be linked into the numbers in the projection to enable automatic updating of numbers to reflect changes to these assumptions. This will enable management to quickly assess the impact of a change in an assumption to future cash flow.

Once the cash-flow projections have been completed, they should be examined carefully to identify when cash-flow surpluses and deficits are likely to occur.

A cash-flow deficit occurs when the cash available is insufficient to pay expenses as they are due. There are a number of options that should be explored in the event of a cash-flow deficit. These include the following:

• Bank overdraft facility – you may be able to obtain a temporary overdraft facility to enable the business to meet its obligations for a short period of time
• Short-term loans – typically short-term loans attract more favourable rates of interest than long- or medium-term loans
• Accelerate collection of amounts due from debtors
• Reduce or defer expenses – examine your projections to see if any costs can be cut or deferred
• Agree a delay in payment to creditors/lenders
• Fundraising activities – more suited to long-term cash-flow deficit
• Convert liquid assets to cash (eg sell investments) – more suited to long-term cash deficit.

Timely preparation of robust cash-flow projections gives you time to examine the available options and to select the one that most suits your business. It also enables you to go to your bank or other suppliers well in advance of a cash-flow shortage to discuss your options. The projections can also be used by the banks or others to assess your request and will also demonstrate that your business has good financial-management practices, which will support the case for your application.

Once you identify a future problem, you should meet with your bank as early as possible to explain your dilemma and to agree a solution. It is likely to help your case if you can present them with a copy of your detailed projections and explain your assumptions to them.

If, on the other hand, you expect your cash receipts to exceed your payments, leaving you with some excess cash, you will have a number of other options available, such as:

• Using the idle cash to pay down any outstanding loans
• Investing in low-risk short-term investments that yield higher rates of return than your current arrangements
• Purchasing supplies in larger quantities to avail of volume discounts.

While it may sometimes be useful to get advice and help from outside professionals in the area, timely preparation of good cash-flow projections should enable you as a business to spot problems early, giving you time to formulate a plan to address them.

Given the challenging times that companies are now facing, it is imperative for any business to start the process of preparing projections and developing solutions to anticipated cash-flow difficulties as soon as possible.

Ciarán O’Brien is a director in Deloitte’s Audit Services Department. He also advises clients on issues relating to working capital management and cost optimisation.