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Cash Flow Forecasting and Finance Keys to Growth

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Most people’s perception of the accounting field is a profession that works with known facts. How much did the person or business earn last year? How much is owed in taxes? Cash flow forecasting and its relationship to corporate finance involves the ability to look forward. This has enormous value for businesses and represents an opportunity for the accounting firms. Financial planner Bryce Sanders explains.

Jun 30th 2021
President Perceptive Business Solutions Inc.
Columnist
In association with
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Defining cash flow forecasting is easy. The process involves using available and historical data to build a picture of the months or years ahead. In simple terms, you are looking at accounts receivable and accounts payable over a set time period.

Traditionally, short-term forecasting covers a year or less. Long-term forecasting looks a few years ahead. With the cyclical nature of the economy and the risk of unexpected events, it’s difficult to forecast beyond three to five years. Why? Although the economy runs in cycles, their length can vary.

There’s also the disruptive effect of technological development. As an accountant, you can easily see the value for your small business clients. It’s an easy concept to explain because no one drives a car on the highway while focusing their attention on the rear view mirror. They need a strategy allowing them to see ahead and avoid obstacles where possible.

Now consider the lending side. If you are a bank or an investor, you only want to lend or risk money with firms having a high likelihood of paying it back or delivering a return on investment. Lenders and investors need a standardized process for evaluating a company’s future business prospects.

Your small business client isn’t in business alone. They may work with a supplier who provides raw material and products. They ship their finished product to stores without requiring payment up front.

The business that might be borrowing money from a bank is also extending credit to its own customers. How solvent are their suppliers and customers? Your business-owning client needs a standardized way to evaluate risk.

Some businesses might appear to operate on a hand to mouth basis. That doesn’t inspire confidence. A properly run enterprise understands income is often cyclical, especially if the business is seasonal.

They also realize the overall economic trend and movement of interest rates can accelerate or slow down sales. It can also cause poorly financed companies to stretch out their payment of outstanding bills. Businesses need a strategy to model their cash flow forecasting on a short term basis and to understand the financial position of others.

Municipalities can also take advantage of cash flow forecasting in regards to financing needs.  Tax Anticipation Notes (TANs) are an example how a municipality might issue a short term instrument based on revenues expected from taxes paid, often within a 12 month period.

Revenue Anticipation Notes (RANs) and Bond Anticipation Notes (BANs) work on the same logic. You need to forecast cash flow before you can borrow.

The non-profit sector can also benefit from cash flow forecasting when borrowing capital. The nonprofit might run a capital campaign to fund the construction of a new building. Donors give money both now and over time as pledges, usually payable in full over a set period, like three years.

The institution needs the money now to finance construction. They borrow against the basket of pledges from a local bank.

Cash flow forecasting can model how much is expected to come in over a defined period, providing funds to pay off the loan. You would want the pledges to be binding and in writing. There are issues, however. The bank shouldn’t be expected to lend full value, much as they don’t lend 100 percent of the value of a property when making a mortgage. There might be problems in collecting some pledges.

Long-term cash flow financing ties into finance and lending when expansion plans are discussed. If revenue and demand have been growing, the business may forecast a time when it will be operating at full capacity.

They may want to move to a larger space, open more stores or purchase more machinery. These all require outside financing. The business may be managing its working capital well and their Treasury position may look good concerning cash and short term cash equivalents, but they will need another, larger source of funding 

Cash flow forecasting is part of the business plan the owner will be presenting to potential lenders. They may be satisfied the company’s credit history is sound, but they want to understand why the proposed expansion makes good business sense.

Conclusiuon

Cash flow forecasting presents several opportunities for accountants relative to their growing relationship with their business clients. Providing cash flow forecasting on a short term basis alerts the business owner if they risk running out of money or will need to be relying on thein line of credit to carry them through to better times.

Long-term cash flow forecasting helps determine if expanding the business is practical or risky. If your client is in the business of lending money, availability of this data helps evaluate each borrower.

Your client depends on suppliers and might extend credit to customers. Cash flow forecasting data helps quantify the risks.

Accounting professionals that are looking to offer financing application support for small business clients are invited to download ForwardAI’s latest guide on How Lenders View Financing Applications. Learn how to review your clients’ General Ledger with the mindset of a lender and help them position their business for success. Download it here.

 

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