Cash forecasting and liquidity control - Short-term cash for...

Learning Outcomes

After reading this article, you will be able to explain the purpose of short-term cash forecasting and its role in managing liquidity. You will identify key components of a cash flow forecast, describe techniques for monitoring cash balances, and recognise the importance of timely cash monitoring and controls for sound financial management and exam success.

ACCA Financial Management (FM) Syllabus

For ACCA Financial Management (FM), you are required to understand the management of cash flow and liquidity in the short term. In this article, focus your revision on:

• The reasons for preparing short-term cash flow forecasts and their use in managing liquidity
• The structure and preparation of short-term cash budgets
• Methods for monitoring actual cash flows against forecasts
• The risks of poor cash management, such as insolvency and missed investment opportunities
• The importance of rapid responses to emerging cash flow issues

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. What is the main objective of preparing a short-term cash flow forecast?
2. Which of the following items is typically excluded from a short-term cash budget? a) Depreciation b) Receipts from customers c) Payments to suppliers d) Staff salaries
3. True or false? Cash flow forecasts can help identify potential liquidity shortfalls before they create major issues.
4. List two key methods managers can use to monitor actual cash movements on a daily basis.

Introduction

Sound cash forecasting and liquidity control are essential in financial management. Even profitable organisations can encounter severe problems if they run out of cash to settle obligations as they fall due. The ability to predict and monitor short-term cash flows enables businesses to make timely decisions to maintain liquidity, avoid unnecessary borrowing, and ensure operational continuity. This article outlines the process of preparing short-term cash forecasts, examines key monitoring techniques, and highlights common challenges in maintaining liquidity.

Key Term: cash forecasting
The process of estimating future receipts and payments over a defined short-term period, helping organisations anticipate periods of surplus or deficit.

Key Term: liquidity control
The ongoing management and monitoring of cash inflows and outflows to ensure sufficient cash is available to meet obligations as they arise.

PURPOSE OF SHORT-TERM CASH FORECASTS

Short-term cash forecasts provide visibility over the expected movement of cash, usually covering time frames from daily up to three months. The principal aims are:

• Ensuring the business has enough cash to pay suppliers, wages, and other essential costs
• Identifying periods when additional short-term financing might be needed
• Planning for periods of surplus, so excess cash can be invested effectively instead of lying idle

Producing regular forecasts allows managers to take early action to arrange borrowing, negotiate payment terms, or invest surplus cash to earn a return.

Preparing a Cash Budget

A cash budget is the practical tool used to summarise all expected cash receipts and payments:

• Receipts: Customer payments, proceeds from asset sales, loan drawdowns, capital injections
• Payments: Supplier invoices, payroll, rent, interest, loan repayments, tax, capital expenditure

Non-cash items (such as depreciation or bad debt provisions) are excluded.

Once all expected receipts and payments are listed, the closing cash balance for each period can be calculated by adjusting the opening cash position for net cash movements.

Worked Example 1.1

A company forecasts the following for the next three months:

Calculate the expected closing cash balance at the end of each month.

Answer:
Month 1 closing: $10,000 + $12,000 - $15,000 = $7,000
Month 2 closing: $7,000 + $14,000 - $9,000 = $12,000
Month 3 closing: $12,000 + $13,000 - $16,000 = $9,000

MONITORING CASH FLOWS AND LIQUIDITY

Producing a forecast is only the first step. Actual cash movements must be reviewed regularly against plans. Effective monitoring includes:

• Reconciling daily or weekly bank balances to forecasts
• Investigating variances (unexpected movements)
• Adjusting forecasts and planned actions based on up-to-date information

Tracking actual receipts and payments helps identify emerging cash shortfalls or surplus earlier, supporting prompt decision-making.

Key Term: bank reconciliation
The process of comparing the cash balance per books to the bank statement balance, adjusting for timing differences or errors.

Key Term: variance analysis (cash)
The examination of differences between forecast and actual cash flows, identifying causes so management can take corrective action.

Worked Example 1.2

Suppose a business expected a cash inflow of $4,000 from a major customer in Week 2, but the funds were not received. What should the finance manager do?

Answer:
The manager should investigate the reason for the delayed payment (contacting the customer if necessary), update the forecast to reflect the new expected timing, and assess whether the delay will create a cash shortfall that needs action, such as arranging an overdraft or delaying other payments.

CASH CONTROL TECHNIQUES AND RISKS

Managers use several tools to maintain control over liquidity:

• Setting minimum cash balance targets to avoid falling below critical levels
• Establishing authorisation procedures for large or unusual payments
• Using automatic bank account sweeps or notifications for low balances

Businesses lacking proper controls may suffer from missed payments, penalties, damaged supplier relationships, or in severe cases, insolvency.

Exam Warning

Forgetting to update forecasts for unexpected receipts or payments can lead to sudden cash shortages. Always ensure forecasts reflect the most recent information on actual cash flows.

Revision Tip

Review all forecast inputs regularly. Prioritise accuracy in receipts—these are often overestimated or assumed to arrive earlier than they actually do.

Summary

Short-term cash forecasting and monitoring give management early warning about liquidity issues and allow prompt responses to avoid crises. Effective control involves both creating robust forecasts and rigorously tracking actual results against plan. Businesses that neglect these activities increase their risk of cash shortages, unplanned borrowing, and potential business failure.

Key Point Checklist

This article has covered the following key knowledge points:

• The objective and components of short-term cash forecasts
• How to prepare a basic cash budget
• The importance of monitoring actual cash flows and analysing variances
• Key methods for maintaining liquidity control
• Risks linked to weak cash forecasting and liquidity control

Key Terms and Concepts

• cash forecasting
• liquidity control
• bank reconciliation
• variance analysis (cash)