Range of cash flow estimates

Often there is a tendency to place considerable faith in the cash budget simply because it is expressed in impressive-looking figures – perhaps even on a computer printout. We stress again that a cash budget merely represents an estimate of future cash flows. Depending on the care devoted to preparing the budget and the volatility of cash flows resulting from the nature of the business, actual cash flows will deviate more or less widely from those that are expected. In the face if uncertainty, we must provide information about the range of possible outcomes. Analyzing cash flows under only one set of assumptions, as is the case with conventional cash budgeting, can result in a faculty perspective of the future.

Deviations from expected Cash Flows: To take into account deviations from expected cash flows, it is desirable to work out additional cash budgets. We might want to base one cash forecast on the assumption of a maximum probable decline in business and another on the assumption of the maximum probable increase in business. With a spreadsheet program, it is a simple matter to change assumptions an display a new cash budget in seconds.

The final product might be a series of distributions of end-of-month cash without additional financing. The most likely values of ending cash balances are depicted by the highest bar.

Use of probabilistic information: The expected cash position plus the distribution of possible outcomes give us a considerable amount of information. We can see the additional funds required or the funds released under various possible outcomes. This information enables us to determine more accurately the minimum cash balance, maturity structure of debt, and borrowing levels necessary to give the firm a margin of safety.

We can also analyze the firm’s ability to adjust to deviations from the expected outcomes. If sales should fall off, the flexibility of expenses and what can be cut by how much and how quickly. The assessment also must be made the efforts required to the collection of receivables. If there is an unexpected increase in business, estimation may be required for additional purchases to be made and when exactly they are needed. Can labor be expanded? If so an assessment has to be made of the present plant capacity to handle the additional demand. Funds will be needed to finance the buildup and whether the same can be made available. Answers to these requirements provide valuable insight into the efficiency and flexibility of the firm under a variety of conditions.

From the standpoint of internal planning, it is far better to allow for a range of possible outcomes than to rely solely on the expected outcome. This allowance is particularly necessary for firms whose business is relatively unstable in character. If the firm bases its plans on expected cash flows only, it is likely to be caught flatfooted if there is a significant deviation from the expected outcome. An unforeseen deficit in cash may be difficult to finance on short notice. Therefore, it is essential for the firm to be honest with itself and attempt to minimize the costs associated with deviations from expected outcomes. It may do this taking the steps necessary to ensure accuracy and by preparing additional cash budgets to take into account the range of possible outcomes.