Cash flow models

A cash flow forecast is a budget. As for any budgeting exercise, there is a need for clear objectives. For projects, and acquisitions should be considered as projects, the overriding objective should be to add 'shareholder value' to make a return, which logically means that there ought to be positive net cash flows over the period of forecasting: not simply numbers that give a net positive return, but reliable amounts at a realistic date of delivery. The following are required to produce the cash flow forecast:

- the capital cost of the project, that is, the initial and any recurring outlays on tangible fixed assets - buildings, plant, equipment and vehicles;

- the amount of working capital required to cover payments in advance, stockholding, debtors etc;

- knowledge of inflows - income or sales budget, or cost savings;

- knowledge of cost of sales or manufacture;

- knowledge of the headings and likely costs of other direct expenses, eg fuel costs;

- knowledge of any increase in indirect costs or overheads;

- knowledge of the timing of receipts and payments.

It is often the last factor that causes problems in accurately determining cash requirements.

A cash flow model is more than an assembly of figures. Figures are essential, but there must be the supporting rationale for the investment and capital expenditure and evidence of the sources of data from which the cash flow forecast is prepared, with all assumptions being clearly identified.

Cash flow modelling for an acquisition will have an estimate of the cost - the price to be paid, possibly over a number of years, as with a buyout. The amount will be the quantity of cash paid or equivalent value of shares issued, although there will be further particular calculations and assumptions needed with respect to that.

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