When planning the short- or long-term funding requirements of a business, it is more important to forecast the likely cash requirements than to project profitability etc. Whilst profit, the difference between sales and costs within a specified period, is a vital indicator of the performance of a business, the generation of a profit does not necessarily guarantee its development, or even the survival. Bear in mind that more businesses fail for lack of cash flow than for want of profit.
Sales and costs and, therefore, profits do not necessarily coincide with their associated cash inflows and outflows. While a sale may have been secured and goods delivered, the related payment may be deferred as a result of giving credit to the customer. At the same time, payments must be made to suppliers, staff etc., cash must be invested in rebuilding depleted stocks, new equipment may have to be purchased etc. For further information on the cash cycle and working capital, click here.
The net result is that cash receipts often lag cash payments and, whilst profits may be reported, the business may experience a short-term cash shortfall. For this reason it is essential to forecast cash flows as well as project likely profits.
The following simplified example illustrates the timing differences between profits and cash flows:
| Income Statement: | Month 1 |
| Sales ($000) | 75 |
| Costs ($000) | 65 |
| Profit ($000) | 10 |
| Cashflows relating to Month 1: | Month 1 | Month 2 | Month 3 | Total |
| Receipts from sales ($000) | 20 | 35 | 20 | 75 |
| Payments to suppliers etc. ($000) | 40 | 20 | 5 | 65 |
| Net cash flow ($000) | (20) | 15 | 15 | 10 |
| Cumulative net cash flow ($000) | (20) | (5) | 10 | 10 |
This shows that the cash associated with the reported profit for Month 1 will not fully materialize until Month 3 and that a serious cash short- fall will be experienced during Month 1 when receipts from sales will total only $20,000 as compared with cash payments to suppliers of $40,000.
Our Exl-Plan range of financial planners generate fully integrated profit & loss accounts with cashflow statements and balance sheets for up to five years ahead and Cashflow Plan is a specialist cashflow planner covering 12 months ahead, with weekly projections for the initial three months.
