SHORT-TERM
FINANCIAL MANAGEMENT
Chapter 12 – Cash Forecasting
2
Chapter 12
CASH FORECASTING
Discuss the need for short-term cash forecasts,
describe how the process of daily cash
forecasting differs from that used in monthly
forecasting, and explain the receipts and
disbursements, pro forma balance sheet, and
distribution methods of cash forecasting.
Chapter 2 Review…
3


In Chapter 2, we said a firm is solvent when its assets
exceed its liabilities and liquid when it can pay its bills on
time without undue cost.
Liquidity includes both flow and stock.


If cash from operations (flow) is not sufficient to cover current
obligations, the firm needs to draw down other resources (stock).
The cash flow cycle refers to the continual flow of resources
through the working capital accounts.

This results in periods of cash surpluses and deficits.
Cash Forecasting
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


Since cash flows are unsynchronized, uncertain, and
uneven, estimating the amounts, timing, and volatility of
cash inflows and outflows is critical.
Forecasting the cash position is vital.
Short- and intermediate-term cash planning is a vital
process for planning, monitoring, and controlling firm
cash.
Cash Forecasting
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

The objective of Cash Forecasting is to plan ahead
for short-term financing needs and opportunities.
It enables the accurate planning for:
 Cash
Flows
 Cash
Balances
Cash Forecasting
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
Short-term cash forecasts:
 Drive
short-term investing and borrowing decisions.
 Selection
of investment vehicles and maturities.
 Selection
of loan products (size, terms, and maturities).
 Drive
financial policies, including disbursement policies,
credit terms offered, and bank selection.
Forecasting Monthly Cash Flows
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


Typically, a monthly cash budget is prepared for the
upcoming year, which includes cash receipts and cash
disbursements.
It includes all sources and uses of cash, not just cash from
operations.
During the year:

Actual cash is compared to the budget.

This can signal issues and prompt corrective action.


e.g.: Instruct retail stores to run a store-wide sale.
The forecast is updated.
Forecast Parameters
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The planning process is integrated with overall
financial management, and includes:

1.
Forecast Horizon and Interval
2.
Variable Identification
3.
Formulating a Mathematical Model
4.
Model Estimation
5.
Model Validation
Forecast Parameters
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1.
Forecast Horizon and Interval

The Forecast Horizon refers to how far ahead the cash
balance is projected, and usually includes a short-term and
longer-term view.


e.g.: One-month, three-months, one-year and five-years.
The Forecast Interval refers to the units into which the
horizons are segmented.

e.g.: One-month horizon segmented into days, three-month
horizon segmented into weeks, one-year segmented into months;
five-year segmented into quarters or years.
Forecast Parameters
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2.
Identifying the Forecasting Variables

Determine what items should be forecasted and how they are to
be measured.


e.g.: What is ‘cash’ (book bank balance, collected bank balances,
accrual-based cash account, include highly-liquid investments, etc.)?
Decide what to model based on accuracy and usefulness.



e.g.: Inventory purchases, A/R collections, A/P payments, dividends,
tax and loan payments, insurance, other operating expenses, etc.
It should be properly detailed, but not over-worked or overly
aggregated.
The accuracy of the work is higher and the work more detailed with
shorter horizons (usually +/- 5-10% accuracy is adequate).
Forecast Parameters
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3.
Formulating a Mathematical Model

4.
Model Estimation

5.
Select the format and model appropriate for the size and
complexity of the firm (see next slide).
Integrate data into the model.
Model Validation

Monitor the existing model to ensure validity and measure
variances from established tolerances for error.
Simple Cash Flow Model
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Possible Format
13

The line items
for Cash
Receipts and
Disbursements
are first
determined.

The shorter the
time horizon,
the more
detailed the
analysis.
Receipts & Disbursements Method
Possible Format
14

97%
The Cash Forecast (receipts and disbursements) is
crafted from the pro-forma cash flow statements.
Possible Format
15

The timing of receipts and disbursements is then
estimated based on historical customer patterns.
Possible Format
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


The starting point is Beginning
Cash Balances.
Cash Receipts and Disbursements
are forecasted…investing and
borrowing are NOT yet
included.
The difference, [Net Monthly]
Cash Flow, is added to the
Beginning Cash Balance to
calculate the Ending Cash
Balance.
Possible Format
17
The firm includes some minimum
level of cash reserves (target
balance) for uncertainties,
emergencies, and/or bank
compensating balances.
Possible Format
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

Each month is calculated
separately.
Monthly [Net] Cash Flow represents
cash surpluses or shortfalls.

If net cash flow for a period is
positive, it is invested or used to
pay down debt, or both.

If net cash flow is negative, any
investments would be liquidated
and/or additional short-term
funds borrowed.
Cash Flow Analysis Example
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


The firm begins the
year with $1.5 million
in cash and cashequivalents.
After planned activities,
it ends January with
$2.6 million in cash.
The firm has $1.6
million in excess cash to
invest in short-term
securities after covering
the $1.0 million
minimum target.
Cash Flow Analysis Example
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Does not include prior investing/borrowing activities.




In February, the firm pays
dividends.
It not only falls short of the
minimum, it actually runs
out of cash.
After liquidating the
investments, the firm still
needs to borrow $1.0
million from its bank line of
credit.
If the investments are not
liquidated, the firm would
borrow $2.6 million.
Cash Flow Analysis Example
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In March, net cash is
sufficient to pay back
the loan, meet the
minimum, and invest the
surplus ($2.1 million)
Cash Flow Analysis Example
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
It’s possible,
depending on interest
rates, that the firm
might be invested and
borrowing
simultaneously.

Higher yields
accompany longer
maturities.
Cash Flow Analysis Example
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

The cash forecast allows
the firm to pre-arrange a
bank line of credit for the
largest anticipated
shortfall during the
forecast horizon.
This monthly format does
not consider intra-month
shortfalls, which is why a
daily or weekly analysis is
often done for the nearterm.
Cash Budgeting
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
The cash budget allows firms to:
Arrange adequate short-term financing.
 Select short-term investment vehicles and the associated
investment horizon.


It is prepared monthly for the upcoming fiscal year.
It is based on planned sales and operating expenses.
 It is synched with typical billing and payment cycles.
 It is frequent enough to be adequate, but not so long as to
mask imbalances.
 It includes comparisons to previous years, and once done, is
compared to actual results.
