If a business runs out of cash and is not able to obtain new finance, it will become insolvent. It is no excuse for management to claim that they didn’t see a cash flow crisis coming.
So in business, “cash is king”. Cash flow is the life-blood of all businesses – particularly start-ups and small enterprises. As a result, it is essential that management forecast (predict) what is going to happen to cash flow to make sure the business has enough to survive.
Here are the key reasons why a cash flow forecast is so important:
Identify potential shortfalls in cash balances in advance – think of the cash flow forecast as an “early warning system”. This is, by far, the most important reason for a cash flow forecast.
Make sure that the business can afford to pay suppliers and employees. Suppliers who don’t get paid will soon stop supplying the business; it is even worse if employees are not paid on time.
Spot problems with customer payments – preparing the forecast encourages the business to look at how quickly customers are paying their debts. Note – this is not really a problem for businesses (like retailers) that take most of their sales in cash/credit cards at the point of sale.
As an important discipline of financial planning – the cash flow forecast is an important management process, similar to preparing business budgets.
External stakeholders such as banks may require a regular forecast. Certainly if the business has a bank loan, the bank will want to look at cash flow forecasts at regular intervals.
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