Cash Forecasting

1. **Capital Budget
- **Explanation**: Cash forecasting helps in planning for large, long-term investments, such as
buying new equipment, constructing facilities, or launching new projects. By estimating future
cash flows, companies can determine if they have enough cash or if they need financing for
these investments.
- **Example**: If a company wants to build a new factory, it uses a cash forecast to see if its
current and future cash flows can support the construction costs, or if it will need a loan to fund
part of the project.

2. **Production Plan
- **Explanation**: Cash forecasts help in planning production by estimating the cash needed
for raw materials, labor, and other production costs. Knowing the cash requirements in advance
allows the company to adjust production levels and ensure they have enough funds to keep
production running smoothly.
- **Example**: A car manufacturer uses cash forecasts to estimate the cost of materials and
labor over the next few months, aligning production with expected sales and ensuring there’s
enough cash available to avoid production delays.

3. Sales Forecasts
- **Explanation**: Cash forecasts are often based on sales forecasts, which predict how much
revenue the company expects to generate. By estimating the cash inflows from sales, the
company can plan for expenses and ensure it has sufficient cash to operate.
- **Example**: A retail store forecasts an increase in holiday sales and expects higher cash
inflows. The cash forecast helps the store determine if it will have enough cash to pay for
additional inventory and seasonal staff.

In each of these areas, cash forecasting is essential to make sure that the company has enough
funds to support its activities and achieve its financial goals.

Cash forecasts can vary based on **time length** and **approach to cash flows**. Let’s break
down each type with explanations and examples.

Types of Cash Forecasts by Length (Time Basis)

Cash forecasts are created for different timeframes, depending on the company’s needs. The
common types are:

1. **Daily Forecast**
- **Purpose**: For short-term cash planning to manage immediate expenses and daily cash
flow needs.
- **Example**: A company might use a daily forecast to plan for the cash needed to cover
payroll, pay suppliers, or manage receipts from customers on a day-to-day basis.

2. **Weekly Forecast**
- **Purpose**: Provides a slightly longer-term view, helping with weekly planning and
managing weekly cash requirements.
- **Example**: A retailer might use a weekly cash forecast to manage cash for regular supplier
payments and to cover operating expenses for that week.

3. **Monthly Forecast**
- **Purpose**: Used for mid-term planning, allowing the company to anticipate cash needs and
adjust budgets for the month.
- **Example**: A manufacturing company uses a monthly forecast to plan for utility bills, rent,
and other recurring expenses.

4. **Yearly Forecast**
- **Purpose**: Gives a long-term view, helping the company plan for large investments, loan
repayments, or capital expenditures.
- **Example**: A tech company might create a yearly cash forecast to see if it has enough
cash to fund R&D projects or new facility construction over the next year.

Distribution and Scheduling in Cash Forecasting

In cash forecasting, *distribution* and *scheduling* help adjust forecast periods to better suit
planning needs.

- Distribution
- **Explanation**: Starts with data for a longer period (like a year) and breaks it down into
smaller periods, such as months or weeks, for detailed planning.
- **Example**: A company that forecasts annual cash flows may distribute that data into
monthly forecasts. If they estimate a $12 million cash flow for the year, they might break it down
to $1 million per month for better monthly planning.

-Scheduling
- **Explanation**: Starts with shorter period data (like daily or weekly) and combines it into
longer periods, giving a broader view.
- **Example**: A retailer that forecasts daily cash inflows from sales might schedule or
aggregate these into a monthly forecast to understand the total cash available each month.
Types of Cash Forecasts by Approach to Cash Flows

Cash forecasts can also differ based on how cash flows are approached or calculated:

1. **Direct Approach**
- **Explanation**: Estimates cash inflows and outflows directly by looking at expected receipts
and payments.
- **Example**: A business lists expected customer payments and supplier expenses for the
week to forecast cash inflows and outflows directly.

2. **Indirect Approach**
- **Explanation**: Uses net income and adjusts for non-cash items (like depreciation) and
changes in working capital to estimate cash flows.
- **Example**: A company takes its net income for the month, adds back non-cash expenses,
and adjusts for inventory and receivables to create an indirect cash forecast.

Let’s break down the adjusted net income formula step-by-step in a simple way. This formula
converts *net income* (accounting profit) to a cash flow estimate by adding or subtracting
certain items.

Adjusted Net Income Formula:

\[
{Adjusted Net Income} = Net Income} +{Depreciation} + {Amortization}) - {Non-Recurring Items}
+ {Non-Operating Items}{Changes in Working Capital}

Explanation of Each Part:

1. **Net Income**:
- This is the starting point and represents the company’s profit after expenses. However, net
income includes some non-cash items, so we need to adjust it.

2. **+ (Depreciation + Amortization)**:

- **Depreciation** and **amortization** are accounting expenses that reduce net income but
don’t actually involve cash leaving the company.
- **Add these back** because they aren’t cash outflows. Adding them back helps us get closer
to the actual cash flow.
3. **- (Non-Recurring Items + Non-Operating Items)**:
- **Non-recurring items** are unusual, one-time events, like a big lawsuit payout or selling a
part of the business.
- **Non-operating items** are activities not part of the company’s main business, like interest
or investment gains.
- **Subtract these items** because they don’t reflect normal, recurring cash flow from regular
operations.

4. **± Changes in Working Capital**:

- Working capital involves changes in current assets (like inventory or accounts receivable)
and current liabilities (like accounts payable).
- **Add or subtract** based on whether these items increased or decreased cash:
- **Increase in assets** (e.g., inventory, receivables) = **subtract** because cash is tied up.
- **Increase in liabilities** (e.g., payables) = **add** because it frees up cash.

Example to Illustrate:

Imagine a company has:

- **Net Income** of $100,000
- **Depreciation** of $10,000
- **Amortization** of $5,000
- **Non-recurring expense** of $2,000
- **Increase in inventory** by $3,000 (asset)
- **Increase in payables** by $4,000 (liability)

**Adjusted Net Income** calculation:

\[
100,000 + (10,000 + 5,000) - 2,000 - 3,000 + 4,000 = 114,000
\]

This formula adjusts net income to better reflect the company’s actual cash flow by accounting
for non-cash items, one-time events, and working capital changes.