Cash flow: understand how and why cash flow forecasts are constructed

The idea

A cash flow forecast predicts cash inflows and outflows month by month, showing opening balance, net cash flow and closing balance. It is constructed by listing expected inflows (cash sales, debtor payments, loans) and outflows (wages, suppliers, rent, loan repayments), then calculating net cash flow as inflows minus outflows and adding this to the opening balance to give the closing balance, which becomes next month's opening balance. Forecasts are used to identify periods of shortage in advance, arrange overdrafts or loans, plan payments to suppliers, support loan applications and monitor actual performance against plan.

For example: A retailer expecting low January sales can forecast a deficit and arrange an overdraft before it occurs.

What earns the marks

• Identifies the structure of a cash flow forecast: opening balance, inflows, outflows, net cash flow and closing balance.
• Explains the method: net cash flow equals total inflows minus total outflows, and closing balance equals opening balance plus net cash flow.
• Explains that the closing balance of one month becomes the opening balance of the next month.
• States reasons for constructing forecasts, such as anticipating cash shortages, arranging finance and planning supplier payments.
• Explains that forecasts support loan applications and allow comparison of actual results against planned figures.
• Applies forecast construction to given figures, calculating net cash flow and closing balances accurately.

Common mistakes and how to put them right

• Adding outflows instead of subtracting them.

  Put it right: Learners should subtract total outflows from total inflows to find net cash flow.

• Forgetting to carry the closing balance forward as the next month's opening balance, which breaks the running total.

• Confusing cash flow forecasts with profit forecasts.

  Put it right: Learners should note that forecasts record cash timing, not revenue and costs matched to a period.

Exam tips

• Lay out calculations in columns for inflows, outflows, net cash flow and closing balance to avoid arithmetic errors.
• Check that each month's opening balance equals the previous month's closing balance before moving on.
• When explaining why forecasts are used, link each reason to a decision, such as arranging an overdraft for a predicted deficit month.