Cash Flow Forecasting - Cash Collections

Cash Flow Forecasting

Introduction

• Cash Flow Forecasting is vital for effective financial management.

• The cash budget serves as a financial plan that estimates cash receipts and disbursements over a specified future period.

Learning Objectives

• Objective 1: Understand the concept of a cash budget, defined as a forecast of cash receipts and disbursements for the next planning period.

• Objective 2: Comprehend all steps involved in preparing a cash budget.

• Objective 3: Learn cash flow forecasting methods, including:
    - Simple moving average
    - Exponential smoothing
    - Correlation and regression analysis

The Cash Budget

Step 1: Cash Collection

• Understanding cash collection is critical in forecasting cash inflows.

Method 1: Use A/R Balance Pattern to Forecast

• The Accounts Receivable (A/R) balance pattern is utilized to forecast collections from credit sales.

• The A/R pattern helps establish a collection pattern which can effectively project cash inflows.
    - Table of A/R Collection Patterns:
      - INTERVAL SINCE SALE
        - Month 0 (current month): 95% outstanding, 5% collected.
        - Month 1: 55% outstanding, 40% collected.
        - Month 2: 20% outstanding, 35% collected.
        - Month 3: 5% outstanding, 15% collected.
        - Month 4: 0% outstanding, 5% collected.

Forecasting Cash Inflows from Credit Sales

Sales Data

• Monthly Sales Data:
    - January: $350,000
    - February: $400,000
    - March: $500,000
    - April: $300,000
    - May: $425,000

Collections Forecast for May

• Calculation based on the A/R pattern:
    - January Collections:
      $350,000 imes 0.05 = 17,500$
    - February Collections:
      $400,000 imes 0.15 = 60,000$
    - March Collections:
      $500,000 imes 0.35 = 175,000$
    - April Collections:
      $300,000 imes 0.40 = 120,000$
    - May Collections:
      $425,000 imes 0.05 = 21,250$

Total Collections Forecast

• Total for May:
    $17,500 + 60,000 + 175,000 + 120,000 + 21,250 = 393,750$

Practice Scenario

• A company’s prior sales over the last quarter were:
    - January: $150,000
    - February: $300,000
    - March: $450,000

• The company collects:
    - 10% in the month of sale
    - 60% one month after the sale
    - 30% two months after the sale

Expected Cash Inflows in April

• If projecting April sales of $550,000, calculate expected inflows based on the collection percentages.

Method 2: Use DSO to Estimate Cash Collection

• Assuming cash inflows come entirely from sales of hair clips.

• Sales Forecast for Upcoming Year (Quarterly):
    - Q1: $750
    - Q2: $810
    - Q3: $890
    - Q4: $980

• Beginning Accounts Receivable: $120

• Days Sales Outstanding (DSO): 45 days
    - This means the average time between a sale and the collection of cash from that sale is 45 days.

Calculating Cash Collections

• In order to accurately forecast cash flow, it's necessary to:
    - Calculate cash collections for each quarter.
    - Determine ending receivables balance for each quarter.

Exercise Questions

1. Cash Collections for Q1:
      - Options: A) $710 B) $542.50 C) $375 D) $667.50

2. Beginning Receivables Balance for Q2:
      - Options: A) $810 B) $375 C) $472.50 D) $335

3. Total Cash Collections for Q3:
      - Options: A) $890 B) $850 C) $445 D) $1,295

4. Ending Receivables Balance for Q3:
      - Options: A) $890 B) $445 C) $405 D) $850

Session Wrap-Up

• The session reviewed the importance of cash flow forecasting and methods to effectively create a cash budget. Understanding these concepts enables businesses to manage their finances effectively and plan for future cash needs.