Cash Flow Forecasting
New money
Figure 4.4 Projection of the balance sheet
The usual method of projecting the balance sheet is first to determine
the primary asset categories which are linked to sales activities, and then
adjust sundry items and cash to arrive at a preliminary total.
The working investment segment is the logical starting point in balance
sheet projections, since the accounts are a direct function of sales. Working
investment levels can have a significant effect on a firms overall cash
flow, since they are primarily composed of current assets and current
liabilities. In addition, working investment levels are subject to a wide
variety of rapidly changing conditions, and are largely a function of
management discretion.
Working investment needs frequently increase proportionately with
sales. However, there are many factors that can affect each component
discretely, and that can alter the overall relationship of working invest-
ment to sales. To achieve the greatest accuracy in projections, therefore,
working investment components are projected separately.
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Cash flow forecasting of financial statements
The technique usually applied in forecasting the working investment
components is as follows.
1 Examine the historical turnover ratios on the ratio sheet of the spread-
sheet, the relationship of the working investment components to sales (or
cost of goods sold), and determine the causes for these historical ratios:
Sales/accounts receivable Accounts receivable turnover
CGS/inventory inventory turnover
CGS/accounts payable accounts payable turnover
CGS/accrued expenses accrued expenses turnover.
2 Decide on a turnover ratio that reflects your reasonable assumptions
about what is likely to happen in the future to alter these ratios.
Overall factors to consider include the following:
Historical trends – have the turnover ratios been relatively stable,
or have they Fluctuated?
Projected economic conditions – what stage in the economic cycle
do the projections represent, and how will the firm likely react to
the economic conditions? (For example, in a recession a firm may
liquidate inventory in anticipation of continued slowdown.)
Sales assumptions – working investment projections should reflect
the assumptions on which sales have been projected. For example,
sales increases resulting from the anticipated introduction of a new
product line will usually be accompanied by an increase in the
working investment accounts.
Factors affecting individual working investment components – factors
to consider when evaluating the individual working investment
components include accounts receivable (changes in selling
terms as a means of meeting competition or extending markets);
inventory (accounting methods – LIFO, FIFO – purchase commit-
ments, availability of supply, price of raw materials); accounts
payable (changes in term of trade, ability to ride trade, purchase
commitments); and accrued expenses (ability to cut back on work-
force or overhead, changes in the cost structure for labour or
3 Calculate the dollar value of each working investment account by
applying the projected turnover rate for the account to the projected
sales (or cost of goods sold) figure.
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