By Shea S. Saman, CPA, and Dennis R. Kennedy, CPA

CPAs all have some experience developing a budget. This document is typically GAAP-oriented. As such, it results in the budgeting of revenue in the months when work is performed or when you expect to bill the customer, but it does not necessarily reflect when you will be paid. A statement of cash flows reports on past cash flow activity, but it does little in helping to plan future cash activity. Just as an accurate budget is critically important from a planning perspective, most businesses can also benefit from a cash flow forecast.

You would think we would see cash flow forecasts more often, but we don’t. Even the statement of cash flows tends to be third in line behind the balance sheet and income statement. Why, considering the importance of cash, do cash statements and forecasts play second (or third) fiddle? The answer is likely two-fold:

• First, as CPAs we don’t think that way. CPAs generally generate or audit financial statements produced according to GAAP. And reporting in any other format tends to run in conflict with our GAAP-based mind-set.
• Second, many of us, frankly, are not sure how to do a cash flow forecast or where to get started. In this blog, we will help those who may not know where to begin.

The process starts with developing a GAAP-based budget/financial plan. This can be prepared in Excel or by using any number of budget tools and software. If you don’t already have a budget in place, you can use your financial statements as a starting point. It’s important that your budget includes a monthly projection of revenue and expenses; if you are starting with a 12-month budget, use historical trends and input from your business units to determine the seasonality of your revenue and expense activity, and allocate your annual budget across each month. Next, you’ll need to convert your GAAP (accrual basis) income statement to a cash-basis statement; add back any noncash expenditures like depreciation and amortization; and reverse any accruals for noncash revenue and expense activity. This cash-basis income statement is the foundation for your cash flow forecast.

Once you have developed your cash-basis income statement, you’ll need to analyze your balance sheet to capture additional cash activity. For example, accounts receivable will be affected by collections. You can calculate your accounts receivable turnover ratio and days’ sales outstanding, and make assumptions on how quickly you’ll collect those sales over the next several months (as well as new sales generated over those periods). As you review the balance sheet, be aware of other accounts that do not have a direct impact on the income statement: fixed asset purchases, loan payments or proceeds, and material prepaid expenses will need to be accounted for as adjustments to your cash flow forecast. From a presentation standpoint, consider adding them to the cash flow forecast beneath your net income/(loss) line along with the accrual-to-cash adjustments previously discussed. In addition to having developed a cash flow forecast, you’ll also have a monthly pro forma balance sheet.

Just as you would monitor and analyze variances in your budget versus actual results, you should also review and analyze your cash flow variances against your forecast. Use these variances to help refine your assumptions and improve the accuracy of your forecast. As you move forward in time, your estimates will become more precise. Even though the circumstances that influence your financial activity can be unpredictable, having a budget and a cash flow forecast in use will give you the ability to adapt to circumstances and better manage your business. Lastly, and possibly even more impactful, a well-thought out cash flow forecast will earn you a lot of points when it comes time to reach out to bankers for a business line of credit.

Shea S. Saman, CPA, is director of finance and accounting at Central Pennsylvania Food Bank. Dennis R. Kennedy, CPA, is a financial services professional at NYLIFE Securities LLC. Both serve as members of PICPA's Corporate Finance Cabinet.

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