March 27, 2023
Cash flow is the backbone of any business. Without sufficient cash flow, a business can’t survive, let alone thrive. In today’s economic environment, cash flow modelling has become paramount for effective cash flow management.
Cash flow modelling involves creating a cash flow model that projects the expected future cash flows of a business over a certain period. This model helps businesses understand their cash flow situation, plan for the future, and make informed decisions about the way their company operates. In this blog, we will explore why cash flow modelling is so important for businesses.
Understanding cash flow
Before we explain why cash flow modelling is important for businesses, we need to define what cash flow means. Cash flow is the amount of cash and cash equivalents that a business generates or consumes during a given period, including both operating and non-operating cash flows.
Operating cash flow (OCF) is the cash generated from a company’s regular business operations. It reflects the amount of cash that a company generates from selling its products or services, minus the operating expenses incurred. Free cash flow (FCF), is the cash that is available to the company after all operating expenses and capital expenditures have been paid.
Non-operating cash flows include cash flows from investments, financing activities, and other non-core activities. These cash flows are not related to the company’s regular business operations and are usually one-time or irregular.
The importance of cash flow modelling
Now the definition of cash flow modelling is clear, why is it so important? There are several different types of cash flow models, each important to business in its way. Here, we break down the importance of cash flow modelling.
- Planning for the future
Cash flow modelling allows businesses to forecast their expected future cash flows. This helps businesses plan for the future, identify potential shortfalls, and take proactive steps to mitigate any negative impact from outside sources.
By having a clear understanding of their cash flow situation, businesses can make informed decisions about their next investments, future operations, and overall growth strategies.
- Managing cash flow
Cash flow modelling also helps businesses manage their cash flow more effectively. By projecting their future cash flows, businesses can identify potential cash flow issues and take action to address them. This usually involves adjusting their operations, revising their spending plans, or negotiating payment terms with their suppliers.
- Discounted cash flow analysis
Cash flow modelling also allows businesses to perform discounted cash flow (DCF) analysis. This is a financial modelling technique that is used to estimate the value of an investment based on its expected future cash flows. DCF analysis helps investors assess the potential returns of an investment and compare it to other investment opportunities.
- Cash flow statement
Cash flow modelling is also closely related to the cash flow statement. The cash flow statement is a financial statement that summarises a company’s cash inflows and outflows for a given period. Businesses must understand their cash flow situation to effectively monitor their cash flow performance. By using cash flow modelling, businesses can create a cash flow forecast that aligns with their cash flow statement, allowing them to make informed decisions about their cash flow management.
In summary
In conclusion, cash flow modelling is a vital process for businesses to understand their cash flow situation and plan for the future. It helps businesses identify potential cash flow issues, take proactive steps to address them, and make informed decisions about their future investments and operations.
By using cash flow modelling, businesses can create a cash flow forecast that aligns with their cash flow and income statement, allowing them to make informed decisions about their cash flow management. If you need any help or further information about cash flow modelling, please contact us directly.
