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Cash Flow Forecasting Methods

The most accurate technique to predict your company’s cash flow will depend on your business goals, the demands of your management team or investors, and the readily available information within your organization. By analyzing expected income and expenses, cash flow forecasting aids business owners in understanding their cash position both now and in the future. Analyzing the source and likelihood that future revenue will be realized is a crucial part of future income analysis with the different cash flow forecasting methods.

Direct Cash Flow Forecasting

Direct cash flow forecasting is an essential tool for CFOs. This bottom-up approach pairs real-time data from all bank accounts with the most critical cash flow items, such as payroll, accounts payable, leases, and equity payouts. In other words, it forecasts cash flows based on predicted actuals. Because it considers all types of transactions, it offers greater accuracy in short-term forecasting. This tool is helpful for many situations, including volatile or unpredictable cash flows.

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Depending on the business model, a company can use one of two methods for cash flow forecasting. Direct cash flow forecasting uses actual cash flow data, while indirect cash flow forecasting uses balance sheet or income statement data. A combination of direct and indirect methods can be the best option for some businesses in managing a cash forecasting process. The main differences between these two methods are their data sources. If you use the indirect method, ensure you understand your cash flow forecasting software’s limitations before beginning.

Pro-Forma Balance Sheet (Pbs) Method

The Pro-forma balance sheet (PBS) is a way to predict future cash flow by examining the balance sheet at a time in the future. This method focuses on the projected book cash account, which assumes all other balance sheet accounts are correct. This method uses some different derivations, including a combination of the three. This method is usually used in medium-term forecasting.

Using the PBS method is not the best choice for all situations. It is not completely accurate. However, it does capture the actual cashflows. And while using this method is more complicated than the direct method, it is highly recommended for medium-term cash forecasts. The latter is helpful for investment decisions and liquidity management. This method also allows for early warning signals. It is a practical alternative to relying on a forecast with higher degrees of deviation than the current cash balance.

In addition to providing information about the current cash position, PBS can help predict future cash flow. In addition to presenting expected cash receipts from the outstanding invoices, it also provides a picture of the company’s assets and liabilities from a long-term perspective. It helps management assess the company’s financial strength, including its debt-to-equity ratio and liquidity.

Adjusted Net Income (Ani) Method

The ANI method is one of three methods used for cash flow forecasting. It starts with operating income and adds or subtracts changes in balance sheet accounts. This method is handy when a business does not take many risks or diversify its operations. Meanwhile, the Pro-forma balance sheet method looks at a projected balance sheet cash account at a particular point in time. It also uses statistics to reverse large accruals.

The ANI method also uses a measure called adjusted net income. This measure of profitability includes revenue, expenses, taxes, interest, and other items that impact the company’s results. Potential buyers often use this measure to evaluate the value of a company as an acquired asset. Despite its simplicity, net income is prone to manipulation, especially when it is used to evaluate a company’s financial strength.

A cash budget is nothing without liquid capital. Whether it comes from accounts receivable, short-term financing, or other sources, forecasting the availability of cash is the primary input to any budget. It is, therefore, important to factor in usable capital when estimating your business’s cash needs.

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