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Once assumptions on sales, expense payments etc. have been established, a model can be used to produce the cash flow projections which, in turn, indicate the likely future cash balances or banking requirements.

Before using a model for short-term cash flow forecasting, a manager or entrepreneur should: Decide the central purpose of the exercise (internal planning and control, negotiate a loan etc.). Identify the target audience (directors, bank manager etc.)

However, the quality of these projections will be completely determined by the standard and reliability of the underlying assumptions. For example, if forecasts for sales, working capital or costs are unrealistic or inadequately researched, then the value of the model's output is greatly diminished. An impressive set of projections is of little benefit if it is unsupported by experience or research or based on mere speculation. In fact, they could be very damaging, or even destroy the business.

Planning to Project Cashflow

Set the time intervals and horizon (e.g. monthly for twelve months)
Sort out the level of detail required.
Check that all the necessary key assumptions and data are to hand and have been adequately researched.
Compile opening balances for all items which will involve cash flows within the forecasting period.
Think through the likely impact of the critical assumptions on the cash flow projections. If necessary, prepare preliminary forecasts manually to confirm their overall direction and consider the underlying strategic issues relating to sales, funding, costs, stocks etc. As a guide, sales forecasts and debtor & creditor terms are likely to have the most profound impacts on short-term cash flows.

Planning Pitfalls when Forecasting Cash Flow

When preparing cash flow projections, be aware of the dangers of:
Overstating sales forecasts
Underestimating costs and delays likely to be encountered
Ignoring historic trends or performances by debtors etc.
Making unduly-optimistic assumptions about the availability of bank loans, credit, grants, equity etc.
Seeking spurious accuracy whilst failing to recognize matters of strategic importance

These problems can arise as the result of a lack of foresight or knowledge, or because of excessive optimism. They can lead to under-estimation of the cash and other resources required to sustain or develop a business with potentially disastrous consequences.