Cash Flow Forecasting

As a basic proposition, however, the bank as a creditor defines a healthy

cash flow as one in which net cash inflow from the normal operations of

the firm is sufficient to cover both financing payments and the mainten-

ance of the quality and efficiency of its assets. Depending on where the

firm is in its business life cycle, the bank would also like to see some per-

centage of the growth in assets (increasing working investment and gross

plant expenditure) covered by internally generated funds.

Analysis of cash flow concentrates, then, on the debt servicing ability of

the firm. By isolating, in a firm’s cash flow, an amount of cash available

for debt servicing, however, it is important to remember that:

■ this is not an identifiable pool of cash earmarked solely for debt ser-

vicing, and

■ from the corporation’s point of view there may be a number of other

needs equally urgent and necessary to ensure solvency of the business

that are competing for the limited cash available.

Analysis of cash flow, then, cannot merely isolate debt capacity but must

also consider all the factors producing major changes in cash inflows

and outflows. The primary hazard of too much debt compared to cash

generated is the risk of insolvency, and debt servicing is given top prior-

ity as far as the bank is concerned. However, all decisions involving cash

outflows vital to the survival of the firm need to be considered when

evaluating cash solvency.

What are the uses of cash flow

forecasting?

Cash flow forecasting is subject to several types of risks. It is useful,

therefore, to look at these risks by category and identify their salient

features and characteristics.

■ Credit worthiness – a company’s financial condition can be analysed

and tested under various scenarios to assess and enhance the intrinsic

credit worthiness

Cash Flow Forecasting

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■ Project feasibility – a project can be tested using various assumptions

in order to establish whether or not the project is feasible, and what

measures can be adopted to enhance the project’s feasibility

■ Loan structuring – specific weaknesses in the credit can be identified,

thereby enabling the loan facility to be optimally structured in terms

of amount, tenor, pricing

■ Financial covenanting – specific financial covenants can be created

and tailored to the borrower’s financial condition

■ Security perfection – specific shortfalls can be identified and the

resulting credit risk enhanced via the perfection of security arrange-

ments, including assets and guarantees

■ Loan document drafting – financial projections can be used to iden-

tify the parameters of specific issues and problems, which can

subsequently be managed via the appropriate drafting of loan

documentation.

Overview of cash flow forecasting

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