Forecasting Cash Flow
THE ESSENCE oF any plan—whether it covers one year, five years, or longer—is the conversion of economic and business assumptions into quantifiable performance results. And a pro forma projection of a company’s financial statements has become the accepted method for quantifying business transactions—at least in developed economies like the United States, Canada, Europe, and so on.
Although quantifying performance through the use of financial statements—balance sheets and income statements—is as far as many larger companies have to go in their planning cycle, this is not the case in small businesses. While financial statements satisfy the SEC, the IRS, and many other interested third parties, the only projection that can be used on a day-to-day basis by small businesses is the cash flow forecast. Without translating business decisions into cash, most small-business owners and managers would be unable to control their operation or make plans for future changes. As we saw in Chapter 1, cash is definitely king and cash management the basic tool for running a business. The cash flow forecast is the working tool of cash management. Without it, it’s impossible to do your job.
With that as a fundamental principle, this chapter lays out the steps involved in constructing a detailed cash flow forecast, fully integrated with a company’s historical and pro forma financial statements.
Such integration is essential to give forecasts the weight of authority. Stand-alone projections whose cash receipts and expenditures do not flow directly from pro forma financial statements are nothing more than a guess.