Cash forecasts or budgets are the principal tool of cash management. They may be divided into two categories: short-term cash forecasts and long-term cash forecasts.
The dividing line between short-term cash forecasts and long-term cash forecasts is usually one year, though this distinction is somewhat arbitrary.
1. Short-term Forecasts:
Short-term forecasts or cash budgets, routinely prepared by business firms are helpful in:
i) estimating cash requirement,
ii) Planning short-term financing,
iii) scheduling payments in connection with capital expenditure projects,
iv) planning purchases of materials
v) developing credit policies, and
vi) checking the accuracy of long-term forecasts.
Firms use multiple short-term forecasts, of varying length and detail suited to meet different needs.
The commonly used designs for short-term cash forecasts are:
i) One year divided into quarters or months,
ii) one quarter divided into months, and
iii) one month divided, into weeks.
Affirm, hand pressed with liquidity crunch, may even prepare a weekly cash forecast divided into days. The point to be emphasized here is that these multiple formats serve differing purposes and should not be regarded as mutually exclusive.
The principal method of short-term cash forecasting is the receipts and disbursements method. Sometimes the adjusted not income method, is used though this method is employed mainly for long-term cash forecasting.
Receipts and Disbursements method:
The cash forecast, prepared under this method, shows the timing and magnitude of expected cash receipts and disbursements over the forecast period. It includes all expected receipts and disbursements irrespective of how they are classified in accounting.
The items of cash receipts and cash payments and the bases for estimating them are shown in the following table:
From the above table it is clear that the receipts and payments method of cash forecasting calls for information about estimated sales, production plan, purchasing plan, financing plan, and capital expenditure budget. The most crucial input in the entire process, of course, is the figure of estimated sales because various business plans are closely related to estimated sales.
This method has the following:
1. It provides a complete picture of expected cash flows.
2. It is a sound vehicle for exercising control over day-today transactions.
It has the following drawbacks:
1. Its reliability is impaired by delays in collection or sudden demand for large payments and other similar factors.
2. It fails to provide a clear picture of important changes in the company’s working capital movement, especially those relating to inventories and receivables.
2. Long-term cash forecasts:
Long-term cash forecasts are generally prepared for a period ranging from 2 to 5 years and serve to provide a rough picture of a firm’s financing needs and availability of investable surplus in future. Long-term cash forecasts are helpful in planning the outlays on capital expenditure projects and planning the raising of long-term funds.
While the receipts and disbursements method can theoretically be used for preparing the long-term forecast, the method that is generally used for this purpose is the adjusted net income method.
Adjusted net income method:
This method of cash forecasting, resembling the funds flow statement, seeks to estimate the firm’s need for cash at some future date and indicate whether this need can be met from internal sources or not. A format for preparing the adjusted net income forecast is shown in the following table. The information required for preparing the adjusted net income forecast is derived mainly from the corporate budgets.
The principal advantage of the adducted net income method of cash forecasting is that it provides a close watch on working capital changes and enables the firm to anticipate its financing requirements. Its major drawback is that it does not permit the tracing of cash flow even though it is an excellent device for showing the cumulative impact of fund flows.