Updated July 14, 2023
Definition of Cash Flow Plans
Cash Flow Plans (also known as cash flow budgets) are the projection of estimates made by an individual or firm or an organization about the quantum of money expected to be received over a specified period of time & the quantum of money expected to be paid over the same time, and thereby reaching a net cash flow amount.
Explanation
- The word “Cash flow” means cash inflow (i.e., cash receipts) as well as cash outflow (i.e., cash payments). On the other hand, a plan means a detailed & systematic way to do something from the futuristic approach. Thus, a cash flow plan means making decisions for the cash flows available in the future.
- The word “cash” includes cash as well as cash equivalents. Cash equivalent means balance in the bank & short-term fixed deposits. Cash & cash equivalent are the realized form of trade receivables & trade payables.
- Coming back to our topic, any organization needs to have a basic plan about where it will receive the cash & where the cash will be paid. The cash flow plan normally includes the estimates with an approximate date.
- A cash flow plan is also known as a cash budget. The basic version of the cash flow statement is included in the financial statements of any entity. Thus, a cash flow plan is different from a cash flow statement. The first is a detailed version of cash flows & the latter is a summarised version of cash flows divided into three company activities.
How Does It Work?
- If you want to someone $ 100,000 at a certain date, you need to have $ 100,000 before the said due date. That’s the crux of a cash flow plan.
- You have to manage your cash receipts to pay for your liabilities at the right time.
- This management plan can now be made for monthly, quarterly, half-yearly, or even yearly. The most logical cash flow management is quarterly since trade customers may or may pay within a month. A credit period is offered at the time of the sale of goods on credit. Also, the credit period is allowed to us by vendors. Monthly cash flow plans are always in a rush. Six-monthly plans are considered fine. However, annual plans are not logical; who knows what will happen 6 months hence today?
- Any entity starts with the opening available cash flow. The cash balance can never be negative. How can you pay more than what you have?
- The plan is made with probable dates. After the date, the balance is computed for the day. This balance has to be positive.
- The revenue operations done on a credit basis are out of the purview of cash flow plans. The reason is simple; the cash flow plan is concerned only with cash receipts & cash payments.
- The sale of goods is an event, but the cash flow is hit only when the customer pays us. Similarly, payments to vendors for raw materials, trading goods, or any monthly accruals are events, but the cash flow gets a hit only on the dates we have paid them.
- So, the balance is computed after each cash flow. At some point in time, a company may fall short of cash. It may happen that there is no estimated receipt from a customer in that period & we have liabilities to pay.
- In such cases, it has various options, such as taking a cash credit facility from the bank, getting a term loan approved, issuing equity shares, or introducing capital.
- However, if the firm does not wish to change its capital structure in any way, it can request the customers to pay early & it can request vendors to allow a few more days for payments. Such requests are widely accepted depending on your credibility in the market.
- After a certain month has elapsed in many organizations, they specify the exact date the cash flows occurred with the exact amount of cash flows. So, month on month, the plan gets an actual picture of cash flows in the past months. Then, at the end of the year, you have a real cash picture in hand.
Examples of Cash Flow Plans
A company has business production & sale of calculators. It has asked the finance department to estimate cash flows in the next six months reasonably. Following is the cash flow plan prepared by the finance department of the organization:
- Cash Flow Plan for The Year 2021
- Date of Preparation: July 01, 2020
- Approved by: General Manager (Finance)
- Periodicity: Six-monthly plan
| Particulars | Date (DDMMYYYY) | Amount ($) |
| Opening balance of cash | 01-01-2021 | 1,22,500 |
| Cash receipts from customers | 04-01-2021 | 6,58,000 |
| 7,80,500 | ||
| Payment to vendor | 11-01-2021 | (3,25,000) |
| 4,55,500 | ||
| Payment to consultants | 16-01-2021 | (1,25,000) |
| 3,30,500 | ||
| Fixed deposit made in the bank | 19-01-2021 | -50,000 |
| 2,80,500 | ||
| Payment of recurring expenses | 31-01-2021 | -1,75,000 |
| 1,05,500 | ||
| Bank realization from long outstanding customers | 01-02-2021 | 8,45,000 |
| 9,50,500 | ||
| Cash receipts from customers | 12-02-2021 | 5,45,600 |
| 14,96,100 | ||
| Fixed deposit made in the bank | 25-02-2021 | -2,50,000 |
| 12,46,100 | ||
| Payment of recurring expenses | 28-02-2021 | -1,75,000 |
| 10,71,100 | ||
| Cash sale of goods | 01-03-2021 | 1,85,000 |
| 12,56,100 | ||
| Cash purchases of goods | 03-03-2021 | -2,45,600 |
| 10,10,500 | ||
| Bank FD released | 08-03-2021 | 50,500 |
| 10,61,000 | ||
| Sale of Car | 25-03-2021 | 1,26,000 |
| 11,87,000 | ||
| Payment of recurring expenses | 31-03-2021 | -1,75,000 |
| 10,12,000 | ||
| Dividend received | 21-04-2021 | 56,000 |
| 10,68,000 | ||
| Payment of recurring expenses | 30-04-2021 | -1,75,000 |
| 8,93,000 | ||
| Capital Raised by the issue of shares | 20-05-2021 | 12,50,000 |
| 21,43,000 | ||
| A term loan is taken from the bank | 25-05-2021 | 2,50,000 |
| 23,93,000 | ||
| New Plant & Machinery purchased | 25-05-2021 | -17,25,000 |
| 6,68,000 | ||
| Payment of recurring expenses | 31-05-2021 | -1,75,000 |
| 4,93,000 | ||
| Bank FD released | 26-06-2021 | 2,62,500 |
| 7,55,500 | ||
| Payment of recurring expenses | 30-06-2021 | -1,75,000 |
| Closing Balance | 5,80,500 | |
Explanation
- As you can see, the company has maintained a positive cash balance after each cash flow.
- It has plans for fixed assets procurement by raising capital & getting a term loan sanctioned.
- It makes monthly recurring expenses of $ 175000.
- It has received major cash flow from long outstanding customers & thus, the financial health became strong.
Why Are Cash Flow Plans Important?
- For every business in the world, each business person has goals in place. The end goal of any business is to maximize the wealth of shareholders or owners.
- Cash flow management is a crucial task in achieving the said goal. As explained above, cash flows give us a picture of how things are moving.
- Early estimation of cash requirements helps businesses to channel the source of income or inflow.
- A cash crunch (i.e., falling short of cash for running daily operations) is not acceptable for doing business.
- Thus, plans help us to envisage a better picture of movements. Investment-related decisions are made available if there are sufficient funds in the future.
- Cash is a critical resource for households as well as corporates. Household cash flow plans are manageable & adjustable at some level. However, corporate cash flow plans are very crucial. The company has to assess whether it has a sufficient cash balance & whether it will need any finance per se.
Advantages
Some of the advantages are:
- It gives a picture of the estimated realization of cash from customers.
- It can estimate the number of bad debts well in advance by observing the delayed receipt of the amount.
- It predicts the financial health of the entity at each cash flow.
- It assesses the need for short-term finance, if any.
- An entity can plan for major fixed asset purchases in the future.
- The major advantage is keeping track of the receipts & payments.
- It provides a detailed picture for the preparation of the cash flow statement of the company.
- The company can strengthen relationships with vendor or customer organizations easily when they have a plan in hand.
- The company can also predict whether they need to issue capital in the future time or whether they need to apply for a term loan.
Disadvantages
Some of the disadvantages are:
- As said earlier, cash flow plans are only concerned with cash inflows & cash outflows. It has no consideration with a background of events happening before cash occurrence. Thus, the cash plan does not give information about the events.
- The finance department prepares a cash flow plan based on their experience. If the cash flow requirements of other departments are not considered, the plan may fail.
- The future is unpredictable & so does the cash flow plans.
- The company may get false security of cash patterns in case of mistakes in probable dates.
- It is an estimate & anything can change over some time.
- The probability of occurrence is not considered.
Conclusion
Even if there are disadvantages to a cash flow plan, it is always advisable to have a plan in place. We know the future is unpredictable, but something is good than nothing. Planning is always helpful. At least you will know the stream of cash occurrences. The end objective is the optimum utilization of funds.
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