Cash flow forecasting is considered as one of the major decision for the businesses. It helps the organization in getting the overall picture of the cash flows. Here cash flows mean the inflow and outflow of cash from the company (Baker, English, 2011).
In the view of Chen in 2007, cash flow forecasting is a method which helps the organization in estimating the cash flows from the company. For this, the cash flow of the organization must include accuracy and consistency in the organization (Telmoudi, Noubbigh, Ziadi, 2010).
For better analysis, the report has considered an anonymous company naming furnishing building company. The management of the company has founded difficulty in forecasting cash flows accurately due to deficiencies in forecasted figures and actual figures. Hence the management of the company needs an appropriate method to take accurate decisions regarding the cash flows (Li, Moutinho, Opong, Pang, 2015).
Cash flow forecast is a method that is considered as relevant to the creditors, investors, rating agencies and employees. Everyone has his/her objective to forecast cash flow statement. The reason behind investors play attention towards the cash flow analysis, is that the investors wants to know about the decisions made by the company regarding payment of dividends and capital appreciation of the investment. While in case of creditors they are interested in cash flow forecasting method to know about the solvency of the company. In case of employees cash flow forecasting is necessary to know the ability of the company to pay off the liability of the company towards the employees. In case of cash flow forecasting, the credit rating agencies also plays a considerable role, as they provides an overview of the company regarding the going concern and the ability of the company to pay off its liabilities (Jury, 2012).
The cash flow forecasting method is considered as one of the considerable statement for the company. The reason behind this is it determines the inflow and outflow of the cash form the company, and the net result of cash flow forecasting is the available cash with the company to run its day to day activities.
According to Keown in 2008, to conduct a forecasting of cash flow the management of the company firstly must analyze the basic concepts of cash flows. It means that in case of complying with the accrual concept the receivables or payment of cash does not matter. It is the matter of when the cash inflow or outflow has to be recorded. It also need to be considered by the management that which expenses has to be included in the income statement and in the balance sheet of the company, that is if the expenditure has been done for short term period, it should be considered as short term expenses and to be included in the income statement of the company not in the balance sheet.
According to Aziz, 2013 it has found that cash flow are of two types that is positive cash flows and negative cash flows. Here positive cash flows determine about the cash receivables while negative payment is considered as negative cash flows. The net cash flow is the difference between the positive cash flows and negative cash flows of the company. Here positive cash flows is arrived from cash receivable from the debtors and sales, while negative cash flows can be arrived due to payment of variety of payments such as payment to labor, materials etc. in cash of cash surplus the company can self finance, while in case of cash deficit, the company has to take finance from finance providers.
According to Epstein in 2011, cash flows can be divided into three activities which are as: operating activity, investing activity and financing activity. Operating activities are those activities which are directly related to the operations of the company, while investing activity comprises of purchase and sales of the investments, and at last financing activities consists of share capital and debt capital of the company.
According to Rajendra in 2013, the main objective behind preparing cash flow forecasting is to forecast the company liquidity position that is its inflow and outflow in advance. The cash flow forecasting also describes about the requirement of cash in future. The forecasting of cash flow ensures the management of the company that whether the company is fully utilizing its available cash or not, or whether there is any requirement of more funds in the future period or not. It has been analyzed that effective cash flow forecasting leads to reduce the cost of capital and leads to increase in the return over cash.
Effective forecasting of cash flow statement can only be achieved if forecasting method supports managerial decision making and enables management of risk. The main objective of risk management is to make the management aware of future cash flows and managing them in an effective manner.
The management has to consider that to effectively do cash flow forecasting the management has to take accurate and reliable information. The reason behind this is, it would lead to ease in the comparative analysis of the company from its past figures. Hence better information can lead to better cash forecasting.
According to Epstein in 2011, the financial accounting standard board prefers direct method. The reason behind this is, it does a comprehensive analysis of the payment and receivables. This helps the management in doing better forecasting.
While Rajendra in 2013, has said that for short term cash flow forecasting direct method is highly preferable. The reason behind this is it simplicity and it includes the estimated cash outflows and cash inflows. This can be easily computed on MS-Excel. According to Sharma in 2009, to correct forecast the cash flows, the management has to be aware of all the transactions which can lead to cash flows in the company (Kirkham, 2014).
Apart from direct method to forecast cash flows, indirect method is also suggestible. Indirect method is also known as net income method. It helps the management in doing forecasting of cash for long term period. In this the cash receivables and cash disbursement are not considered while in this method, earnings before interest, depreciation and taxation are considered. The changes in the earnings before interest, depreciation and taxation are added in the account payable, account receivable, inventories are added (Wyatt, 2012).
According to Farshdfar & Monem in 2013, whatever the method is adopted by the company, it would help the management in predicting the ability of company for its future cash flows. For this Farshdfar & Monem have done an analysis over 348 companies between the periods of 1992 to 2004. According to their analysis, they have found that direct cash forecasting method is a suitable method for aggregating the operating cash flow. Besides this, it has also been analyzed by them that direct method of cash flow forecasting presents more information as compare to indirect cash flow forecasting method that is useful for analysts and investors.
In the view of Krishnan and Largay in 2000, the only difference between the direct cash flow method and indirect cash flow method is in the net income and operating cash flows. Whatever the method has been chosen by the company it would not affect the net cash flows.
According to Clacher et al in 2013, despite of positive points of direct cash flow forecasting method, companies at global level prefers indirect method, while in case of academic professionals direct method is preferred. International accounting standard board and financial accounting standard board recommends direct method to be followed by the companies for forecasting cash flows. The reason behind this is that direct method brings more explanatory information which results into increase in accuracy level of forecasting cash (Linzer, Linzer, 2008).
GAP analysis is also called as Delta analysis (Δ). This analysis describes about the changes that the company should make to reach at its desired goal. GAP analysis is done by finding out the differences in the view of different authors (Tennent, 2012).
The company has followed indirect method of forecasting cash flow, this method is inaccurate, the reason behind this is; indirect method of cash flow analysis does not provide a true and fair picture of the receivables and payables. The reason of inaccuracy in adopting the indirect cash flow method is that, the method does not differentiate between the interest free debt and interest bearing debt (Great Britain: National audit office).
This has led the requirement of adopting new method of cash flow forecasting, but to adopt this; the management of the company was requiring a large amount of money, time, resources etc. the reason behind this is the project of the company is so large that to adopt this the company requires technical up gradation. Apart from these, it has been identified that the indirect cash flow forecasting method excludes some transactions which leads to outflow of cash from the organization such as: VAT payable, interest bearing debt etc (McCallion, Warner, 2010).
Hence to avoid such differences the management of the company has decided to follow direct cash flow forecast method. It has been analyzed by the management of the team that direct method of cash flow forecasting gives more accurate results as compare to indirect cash flow forecasting method. It has been analyzed that if the company such as in the given case of furnishing building company which works at a big level has very complex structure of operating activities. This lays complexity in defining the cash flow attributes. Apart from this, it has been analyzed that the company financial structure consists of various projects, which leads to increase in the level of complexity. Furthermore, it has been observed that in case of following the accrual base of accounting, the company sales and expenditure does not include value added tax payable, due to which the cash flow of the company does not represent a true picture.
One more gap has been identified in the cash flow forecasting which is, the system cannot be fully automated, because it is presumed that the business controller has better knowledge regarding the forecasted figures and their respective presentations (Samonas, 2015).
To effective implication of the cash flow forecasting method, it is said that the cash flow statement cannot be implemented without the contribution of management. The reason behind this is, without the support of the management, the company would not be able to implement the forecasting method effectively (Dropkin, Halpin, Touche, 2012).
By analyzing the report over cash flow forecasting, it is suggested for the company that to bring accuracy and realistic concept, the management should prepare the cash flow statements annually rather than on monthly or weekly basis, as this would lead to more accuracy and consistency in the forecasting of cash flow. There are two methods for forecasting of cash flows in an organization which are as: direct cash flow method and indirect cash flow method.
By analyzing the report it is concluded that the cash flow forecasting method leads to increase in the anticipation of future availability of cash and borrowing that would be required by the company. In comparison between direct cash flow forecasting method and indirect cash flow forecasting method, it has been analyzed that direct cash flow forecasting method has to be preferred. The reason behind this is indirect cash flow forecasting method does not gives true and fair picture of the financial statements. In spite of this, it has been observed that companies at global level prefer indirect method for forecasting due to ease. At last it is to conclude that whatever the method is adopted by the company it would not make any affect in the net cash flows.
Aziz, R. F. (2013), Optimizing strategy for repetitive construction projects within multimode resources, Alexandria Engineering Journal, vol. 52, no. 1, pp. 67-81.
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