The 13-week cash forecast can serve as a tool for both cash management and communication with lenders.

September 01, 2016

Is cash really king? Just ask distressed businesses that have failed to keep that cliché in mind.

Having cash in the bank — and even having a growing account balance — does not mean that a company has positive cash flow. Lenders want to know that a company — especially a distressed company — has adequate liquidity and will generate cash from operations. Stout recently worked with a specialized manufacturing and fabrication company that prepares its monthly financials based on progress billings. The monthly financials showed the company was generating revenue, but due to the length of the company’s projects, very little cash was actually flowing in. The resulting cash shortfall rendered the company unable to make debt payments or pay vendors.

This article focuses on the 13-week cash forecast, which can serve as a tool for both cash management and communication with lenders. It explains what a cash forecast is (and isn’t), how it is prepared, mistakes commonly made in a forecast, how it can be used to control cash, and how it differs from profit and loss projections.

What is a cash forecast?

A cash forecast reflects the timing of cash inflows and outflows by projecting receipts and disbursements.

The first step to understanding a company’s liquidity position is to determine the company’s immediate and short-term cash needs. A cursory look at the company’s bank account is not sufficient. A worthwhile analysis considers expected cash receipts, restricted cash or amounts in escrow, payables due, required debt payments, and availability under any credit facilities. The most frequently used tool to communicate this information is the 13-week cash forecast. A well-prepared 13-week cash forecast can help managers control or monitor cash disbursements each week as well as communicate to lenders and other stakeholders that the company actively monitors its cash position and proactively responds to potential liquidity concerns.

Unlike projected financials, which are typically prepared on an accrual basis, a cash forecast reflects the timing of cash inflows and outflows, meaning it can be relied on to project borrowing required to cover payroll or insurance premiums, or excess cash available to pay down credit facilities. Based on a cash forecast, a manager may elect to delay payments to noncritical creditors in order to meet an upcoming payroll or other critical payment.

Most 13-week cash forecasts follow a common format:

  • The beginning cash balance
  • Cash receipts and cash disbursements for each week
  • The ending cash balance

Several other common variations exist. For example, some forecasts separate cash activity related to borrowing and/or revolver payments and interest payments. Others include cumulative totals, such as net change in cash over a given period.

How is a cash forecast prepared?

Regardless of industry or company, the general format of a cash forecast is the same. However, the value of a cash forecast correlates to the level of detail included in the forecast. Especially in the case of a distressed company, the more attention the company pays to details, the more valuable the forecast will be.

In preparing a forecast, a manager should consider how the company reports financial information and uses it to make business decisions. For example, say a business is considering closing certain locations in order to bring operating costs within gross margin levels. In this case, the forecast should show receipts and disbursements by location. The disbursements would show the total operating costs, SG&A and restructuring costs associated with each location. Presenting only the total cash receipts and disbursements for each location would not be sufficient; underlying detail that supports the summary-level information would be necessary. Therefore, additional schedules would need to be used to gather and organize supporting details. SG&A could be broken down further to project disbursements related to payroll, insurance premiums, office expenses, IT and cloud services, rent, and utilities. The subtotals for each section on the supporting schedule should feed into the cash forecast.

Because many areas of a business work with cash receipts and disbursements, a manager must identify who will supply information and who will collect information weekly. Operations managers can provide insight on the timing of delivery of goods and completion of jobs. Payables and receivables clerks and controllers know when cash is expected to be paid or collected. Information regarding the timing of payroll decreases or severance and accrued PTO payments may come from HR as the company decreases its workforce. In smaller businesses, an office manager may be the person most familiar with how and when regular expenses (e.g., telephone, internet, rent, insurance premiums) are paid.

A manager may need to educate these stakeholders on cash forecasting in order to gain their buy-in for the processes of preparing and maintaining a forecast. Especially in distressed companies, middle managers may be reluctant to invest time in preparing data, or they may not consider all cash disbursements.

Using the accounts payable aging schedule is a quick way to project at least a few weeks of cash disbursements. Depending on a company’s bookkeeping practices, certain regular expenses (e.g., rent, insurance premiums, payroll, payroll taxes) may not appear as a payables account. Furthermore, company credit and debit cards or subscription services may be set to auto-pay in order to avoid late payments, making it difficult to predict and control cash outflows. As such, distressed companies should consider canceling corporate credit and debit cards and/or turning off auto-pay.

How can a cash forecast be used to control cash?

The cash forecast should be updated weekly, with actual costs — including electronic and ACH payments, wire transfers, and any checks released for payment — recorded next to the forecasted amounts for the prior week. When disbursements are recorded as they are released, the cash forecast reflects cash balances net of any float period.

A standardized variance report shows the variation from budget in each receipt and disbursement category, and variances beyond a predetermined threshold percentage should be explained as either “timing” or “permanent” variances.

Timing variance

A timing variance occurs when a receipt or disbursement is paid in a period before it is forecasted. In the next forecast, the cash flow should be adjusted to include the receipt or disbursement. Timing variances can indicate that receivables are being collected sooner, or vendors are being paid sooner, than forecasted. Paying close attention to timing variances will not only help manage the cash conversion cycle and working capital float but also refine the forecast assumptions.

Permanent variance

A permanent variance occurs when a receipt or disbursement differs from the forecasted amount or was not included in the previous forecast. Permanent variances, which are typically disbursements, can indicate several issues:

  • The company has not considered all expenses in preparing the forecast
  • The company is paying fees in addition to forecasted expenses
  • The company’s cost reduction efforts have not been as successful as forecasted

How is a cash forecast different from profit and loss projections?

Many businesses that have never put together a cash forecast find their first attempt at doing so illuminating. The experience can be like buying a car: The only way to discover the unique quirks — where the controls are located, or how long it takes the transmission to shift — is to take it for a test-drive.

The ins and outs of cash forecasting will help management identify excess costs and unnecessary business practices that impact the timing of cash needs, or that certain costs are more controllable than others.

To illustrate the level of insight a cash forecast can provide, consider this example: The manager of a distressed company that had never before prepared a cash forecast told Stout that the process helped him determine whether, after downsizing and rightsizing his business, there was any actual value in continuing as an operating company.

Not only is the 13-week cash forecast a tool for controlling cash, but it can also be used as a storytelling device in dealings with lenders. Banks and other lenders recognize the positive effects of cost reduction efforts in 13-week cash forecasts. In fact, without a distressed company’s cash forecast to demonstrate otherwise, lenders could assume that the company has not reduced or cannot reduce costs to a level that allows sufficient liquidity for continued operation.

By sharing cash forecasts with lenders on a weekly or a monthly basis, management can maintain or regain credibility with lenders. Cash forecasts signal to lenders that management is proactively responding to liquidity concerns and is capable of controlling cash when variances to the forecast are kept to a minimum and thoroughly explained. More important, cash forecasts allow lenders to see that although management has taken steps to scale back operations and cut costs, the positive effects of these steps may not be visible on a cash basis for several weeks while existing invoices are paid, new insurance rates are put in place, and accrued vacation and severance are paid to terminated employees.

In some cases, projected profit and loss and financial statements are more appropriate than is a 13-week cash forecast. Typically, projected financials are prepared on an accrual basis rather than a cash basis and show debt covenant calculations such as EBITDA (earnings before interest, taxes, depreciation, and amortization), debt service coverage ratio and leverage ratios. In addition, projected financials show longer periods, ranging from 12 months to several years.

Although projected financials do not contain the granularity and detail of a 13-week cash forecast, they are another important tool for communicating with lenders. Stout Risius Ross recently helped a wholesaler/distributor negotiate its existing line of credit with its bank. Until loan officers reviewed the cash forecast and projected financials, the bank had assumed the company would continue losing money through the end of the year. The cash forecast showed that management’s cost savings from head-count reductions, payroll cuts, location closings and minimized inventory purchases would result in positive cash flows within weeks, as soon as the one-time costs associated with those actions were disbursed. However, the projected financials told the rest of the story: The company was liquidating its inventory to generate cash and pay down its line of credit, and it had sufficient inventory to continue selling while making minimal purchases for 12 months. By providing both the cash forecast and the projected financials to the loan officers, the company ensured that the bank had sufficient information to decide to renew the company’s line of credit.